Jan

23

 From a shareholders' perspective, Solar City Corp (SCTY) could be a disaster. My concern is the company's future is not in Musk's control. States will likely change their energy policies. If those policies go the wrong way, SCTY's shareholders could be left holding the bag. The odds of those policies hurting SCTY are significant.

SCTY discloses risks in their 10-K. Everything seems proper. However, it seems to me the sizzle, Musk's name, the linking of SCTY to TSLA and such could be distorting the public's perception. That perception and other forces have inflated the company's market cap to unwarranted levels. The present value of their future leveraged cash flows is nowhere near their market cap of $6.5 billion.

On the other hand, if Musk can navigate some tricky turns, SCTY could become another Google.

Henry Gifford writes: 

Any analysis of the industry cannot be complete without looking at the economics of the products the industry produces.

I have found that solar electric systems have an ATR of about 20. The ATR is the actual payback divided by the average claimed payback (Average Truth Ratio).

The financial return from solar electric panels can be calculated in a fairly straightforward way.

Systems now cost approximately $7.00 per Watt. That is the price including panels, other parts, and installation, according to Sharp USA, claimed to be the largest or near-largest supplier in the US.

A Watt is a rate, not a quantity. The rate of one Watt of capacity is at noon for an ideal installation. This brings up the question of how many noon-equivelant Watts of power a system will make in a year. The answer, in the 48 states, is about 1,150 to 1,200. The variation is not as great as one might expect, partly because the sunnier locations are hotter, and panels do not work well in the heat.

Producing electricty at the rate of one Watt for 1,200 hours yields a quantity of electricity called 1,200 Watt-Hours.

The numbers above are for DC (Direct current, like a flashlight battery with a + and - terminal) producted by the panel. There are losses when converting to AC (Alternating Current, as used in wall outlets) and in the wires, leaving perhaps 1,000 Watt-Hours per year. The utility companies call 1,000 Watt-Hours of electricity a KiloWatt-Hour.

As of a few years ago, the US average price of a KWH was $0.09 (nine cents). I do not know if it is higher or lower now, but I know it fluctuates.

To find the "simple payback," which is the years for the system to pay for itself, you divide the cost of the equipment and installation by the dollar value of electricity produced in one year. $7.00 divided by $0.09 yields a simple payback of 78 years.

Note that the panels start degrading they day they are installed, and have a useful life of 20 to 25 years. In other words, the payback period is three times the equipment life.

In places where electricy costs more, saytwice as much, or $0.18 (eighteen cents per KWH), the payback would be 39 years.

Note that my analysis is simplified, and a more sophisticated analysis would include the increasing price of electrictiy, while ignoring the future decreasing value of the money used to buy the equipment, which would make the payback unrealistically shorter, as the increasing price of electricity is a combination of the lowering of the value of the money and the expected increase in the value of the electricity.

And it is worth noting that this analysis does not apply to a typical installation, as a typical installation is not mounted at the optimin angle (latitude dgreees from horizontal) or oriented due south, and located where it is never shaded. Typical installations are not optimally angled or oriented, and are often at least partially shaded. Partial shade degrades the output from all the panels in a series, and can permanently damage the panels. With government "incentives" (something the ATM machine calls cash) ever increasing, it is common to mount panels verticaly (mounts are cheaper) where lower incidence of sunlight and increased reflection greatly decrease output, or horizontally, where increased reflection and increased dirtiness decrease output even more, and with disregard to azimuth (North-South orientation), even mounting them facing north on award winning buildings.

Therefore, from a financial standpoint, it is cear to me that the whole industry is a farce, just a taxpayer supported way of making a social statement while supporting many people highly skilled at filling out paperwork.

Solar thermal panels have, I think, a much more favorable ATR of about 10, but it is impossible to calculate the payback, because calculations require simulations of the amounts of hot water used and the times the water was used, and must make assumptions about the very common installation problems that in typical installations seriously reduce the useful production. But as solar thermal systems are usually not the recipients of tax money in nearly the same amount as solar electric, if at all, solar thermal systems are usually ignored in discussions of the solar industry.

If the price of either solar electric (PV) panels or solar thermal panels drops to zero, the economics of the industry would not change much, as the panels are about 1/3 the cost of a solar electric installation, and perhaps the same for a solar thermal installation.

Oct

1

Newspapers can influence elections, and that makes them very valuable to politicians. The economics of buying a newspaper is easy to understand when you remember that politicians spend millions of dollars to get hired for their job that pays a few hundred thousand dollars per year.

Feb

15

 For about 3 years, I've been monitoring the trend in public notices of foreclosures and sheriff sales in the local newspaper. These have gone from nearly a full section 2-3 years ago, to several pages a year ago, to near zero today. Similar observations in other locals while traveling have been made.

It looked a couple of years ago that goo would be flushed from the system by the second half of this year. The upward trend in new construction, home prices and building materials in the last half of last year caught me by surprise as well.

Out here in the boonies [at least in my boonies], we were not hit nearly as hard as the coastal regions in either the housing or employment markets. In reviewing and measuring housing, let's not forget……geography matters, as does what is selling.

I wanna think maybe this is a combination of having paid down or reorganized our debt, learning our lesson about over-extending and being house-poor, having begun to save and invest and spend more wisely again, and with the market up we're feeling better about our fortunes and the future, we notice there are still vestigial housing deals out there as well as new ones, recognize they might not be there for long as home prices are increasing, and figure the time is right to buy again. Kind of like recognizing a market bottom has occurred and buying in at the beginning of the upswing.

I don't think this is a head fake, but a certain amount of prudence is not ill-advised, because, as we saw in 2007, nothing lasts forever.

Henry Gifford writes:

One time I was negotiating to buy a house and I told the seller "Your house is in mint condition." The broker in the background was cringing, and repeatedly recommended I hire a home inspector, and the only thing that would quiet her down was explaining that the home inspectors have an association, which has a magazine they read to learn about what to look for when they inspect a house, and the latest issue had a cover article I had written.

I told the seller I was going to make an offer to the realtor within the hour, and my offer would be contingent on me not dying. No mortgage contingency, no inspection, no nothing. We agree, we sign, we close.

My offer was lower than other offers that day. We closed soon after without hassle.

When selling property I generally ask for an "as is" contract, to avoid the games.

The legal side of it all says that a seller is more obligated than a buyer because "specific performance" says the seller is promising something very specific (a unique house) while they buyer is not. As a practical matter, a buyer can threaten to sue for some obscure term of the contract, tying the property up indefinitely if they are not refunded all their money.

It is all just another way honest people are at a huge disadvantage in life, but it is the life I have chosen.

Jim Lackey writes:

A hold back near nashvegas: rent exceeds the cost of carry here. Even @ 0% down FHA rate + tax tag and title (yet minus the unknowable maintain costs) if you rented it yourself, no management fees, i.e, rent 1500 per month, cost of carry 1200 on 4br all brick nice hood and schools. Yeah, if it was a cash buyer it is grocery store, wait AMZN margins so it can trade 100X earnings. lol. I just figured it out as a few of my friends have moved (bought new new) and held on to their old house and we have renters in the hood. Yet, it's still cheaper to buy new vs. used. Hipsters are in deep buying East Nashville tear down/ guy rebuild. My buddy told me it was dead 20 years ago. His new wife as a college kid bought dead homes for 3,000 bucks. Yes, you can imagine correctly.

Jan

21

 Any doubts about Apple under Tim Cook being different than the Apple under Steve Jobs are gone by now. Apple capex is up, there's a swing in production back to the US, and there have been at least one "significant" software disaster. Now come the reports of changes in the product cycles and product introduction schedules. Apple hasn't shied from cannibalizing its products in the past, so I don't this it will pause from doing so now. I'm wondering at what point does the smartphone market go generic? Conventional wisdom is that with the Chinese now buying smartphones, the market will only expand. Perhaps. But are the Chinese prepared to pay the premiums for smartphones as Westerners have? That's a problem not just for Apple. Then again, I've yet to walk into an Apple store that wasn't packed. Even during the recession.

"Rumor: Apple to debut 4.8" 'iPhone Math' device alongside next-gen iPhone in June"

Henry Gifford writes:

When I bought my phone the guy in the store (in New York City) told me the US Federal government subsidizes every mobile phone in the US to the tune of $600, limit once per person per two years, thus the two year contracts.

Subtract $600 from the price in China and the price is quite similar to the US price.
 

Russ Herrold replies:

Yeah, counter clerks will say almost anything. The truth is more commonplace. Some subsidies exist, nominally for low income folks but the people PAYING FOR that subsidy are … [hint: go read your cell phone bill closely] all the other telephone users. This is a good article about it.

Jan

21

 I suspect that Lance Armstrong's confession on TV had to do with last Thursday's deadline for the US Federal Government to file a Qui-Tam (whistleblower lawsuit) action against him, based on information revealed by Floyd Landis (another doping Tour de France winner who denied doping for years after testing positive).

Qui-Tam lawsuits reportedly date back to the war between the North and South of the US, when the US Federal Government (North) offered a 10% share of money recovered from anyone who squealed on anyone defrauding the government. All the whistleblower has to do is talk, and the feds have a certain time to decide to pursue the case or drop it. If they pursue it, their likelihood of winning is very high, as they have infinite resources and many other advantages, such as the courtroom procedure where they plead their case, then the defendant rebuts, but then instead of the decision being made, the feds get another chance to rebut. This and other advantages, combined with the threat of criminal prosecution, lead many defendants to give up. In Lance's case, I suspect it could cost him more than all the money he has, or would likely be left with after the other people expected to get money from him get what is coming to them.

Press articles while he was still denying doping were in two categories - the ones that mentioned that he had tested positive for doping, and those that did not. He tested positive for steroids in I think his first Tour de France, and afterword produced a doctor's letter saying he had been taking a prescription saddle sore cream containing steroids. A doctor's note after a positive test is no defense, and the rules are clear on that - and printed on the back of every racer's license. But, he was let off the hook because he was a big shot by then, and it was not in the interest of anyone involved with the sport, including sponsors, to have him banned. Much later six of his blood samples tested positive for synthetic EPO.

EPO is a chemical produced naturally in the human body, which stimulates production of red blood cells. The fake stuff does the same thing, and was at one time the most commonly prescribed drug in the world. For an athlete, extra red blood cells mean increased Oxygen carrying capacity, which means riding a bicycle up a mountain without getting out of breath. And in training it means stressing the muscles all that much more than a person with normal aerobic capacity could do.

 There are a least four ways to increase red blood cell count, two of which are legal in bike racing, two of which are not. The two legal ones are training at a high altitude, and sleeping in a tent at night with reduced Oxygen levels, both of which champions have done. The two illegal ways are taking synthetic EPO and blood doping, which is removing a pint of blood a month before a race, refrigerating the blood, and then putting it back in the night before the race, leaving the body with extra red blood cells.

In the early 2000s there was no test for synthetic EPO, but a few years ago, when the test came out, samples of Lance Armstrong's blood which was taken in early tours and kept frozen over the years was tested, and all six samples came up positive. That makes 7 positive tests that were widely known to the public during his years of denial. The rest is history.

-Henry Gifford (Former NY State champion bike racer who has never taken any drugs or drank any alcohol).

Russ Sears writes: 

People could forgive the drugs and cheating, but they will not forgive the bullying and using LiveStrong as a front to further this bullying.

I have seen it more than once, when a rational guy starts taking steroids he starts having a g_d complex.

With the new sudden success, and the mangled brain, it leaves him thinking they are above justice, everyone else is blind. The changes seems so obvious to him that he is on juice. The accolades so addicting.

The justification that everyone else is doing it and getting away with it convinces him that fate has singled him out for greatness and he cannot be stopped. He is the only one capable of understanding the truth.

This was true from the kids on each stage level from the c level HS basketball team to the Olympians winning medals. It was sad and pathetic seeing the HS coach confront a juicer, it was an epic tragedy at the elite levels.

Ralph Vince adds: 

Reading Russell's post made me think "Does he mean Armstrong… or Obama?"

Drinking my morning coffee, listening to the what was Florida wilderness out back being churned and converted into housing. Local strip malls, parking space unavailable. I watched Reagan's tax cuts met with a rolling market by August of 82, then watched the largest tax hike in history, announced at the SOTU of 93, met the same interval of time later with another rolling market.

America is so big, it's economy so massive and with a mind of it's own, policy bounces off of the mammoth like the arrows of pathetic, little men. Rome rumbles on. It occurs to me that the president, in all his rockstardom and oprahglamour, is as relevant as Armstrong.

Apr

17

 I offer the following question only because I would appreciate some constructive criticism.

Free markets work well for short term investments, such as publicly traded commodities and equities. The free market falls down in long term investments because they lack liquidity and price discovery for investments lasting 5, 10, 15, 20, 30, 40 or 50 years.

How is a utility to finance capital improvement projects under such circumstances? I'm finding every investment organization I've talked to is unwilling to participate in a US deregulated power market asset because they cannot hedge their investment.

Today, few are financing power plants in deregulated regions because there is no bankable offtaker. The result is few power plants are being built in these areas.

What is the Austrian School's take on this challenge?

Henry Gifford responds:

As for deregulated electricity markets, I think what is currently called "deregulated" is different from what I think of as free market. I will use the California deregulation as an example.

When California deregulated the electricity markets, they formed three new state government agencies, one with monopoly power to sell electricity at the wholesale level. I have no idea what the other two did. The agency signed long term sale contracts with local utilities, and bought electricity from both in-state and out of state (California is a net importer) suppliers on the spot market or on short-term contracts. I repeat - they signed short term purchase contracts, and signed long term sale contracts for set prices. The agency made a few billion dollars of profit in a few years, as buyers were barred by law from buying from anyone else (remember, I am describing deregulation), and the state bought for a lower price than they sold for.

The inevitable happened - short term prices rose above the prices they had contracted to sell for. The state government did the inevitable: they passed price control laws, barring their suppliers from selling at a price that would be unprofitable for the state government (remember, I am describing deregulation). Out of state suppliers refused to sell at the lower prices, so the California governor asked the president to pass price controls for suppliers outside of California. The president did not do this. Meanwhile, suppliers went unpaid. I repeat - the state agency did not pay for what they had bought. Instead of paying, the state demanded to first investigate their allegations of "unfair profits" while the bills went unpaid. As out of state suppliers who were owed money were getting investigated, they refused to sell power to the state, and the lights went out. (repeat: I am describing deregulation). This gave deregulation a bad name for a generation, spawned the usual anti-freedom documentaries, and because the arrangement was called deregulation, free markets were also given a bad name. But, I don't think a government monopoly is a free market, and have never met anyone else who does. Instead, people just keep calling it deregulation and saying deregulation doesn't work, and the free market doesn't work, including many people who know the deregulation involved formation of monopolies, price controls, etc.

Now if you reread the description above, and think of the position you would be in if you were a producer of electricity in California, or were considering becoming a producer, or financing a new power plant, your lack of enthusiasm would be understandable, but have nothing to do with failure of what I think of as free markets, long term or short.

The statement that free markets fall down in long term investments is I think inaccurate. Lack of liquidity is priced into investments that are difficult to sell.

 I don't know what "price discovery" is. Real Estate is rather illiquid, but prices for most transactions are a matter of public record, and advertised prices for comparable properties are always available.

I would invest in an electricity producing plant in California if I thought the price was right. With some looking I would tell you what that price would be, which I think indicates there is no lack of price discovery for long-term investments.

Gary Rogan writes:

 It seems in retrospect that combining regulated rate utilities with unregulated power assets is asking for trouble. It's the same kind of trouble as defined benefits pension obligation funders eventually always have to face: when you promise something definite far into the future but the source of funds for your promise is indefinite, this has to blow up sooner or later for many participants. Nothing is ever really guaranteed and some percentage of attempts to make such promises will either run out of money or will have to ask the government for help. Some bonds in the "real world" become worthless, and some insurance companies promising life-time annuities go belly up.

There must be a long and complicated history of how natural regulated monopolies came into existence, but I bet they were accepted too easily. The real cost of energy cannot be projected too far into the future, and in what I would consider a "fair" world nobody would be guaranteed any particular rate of return, and anybody would be allowed to compete for the end customer's business, with property access rights of course being in private hands is so historically determined. Investments in new sources of power would only be made when the benefits were outrageously obvious or the investors were unwise. Even the wise investors would of course sometimes striker out. That's free market, and that's what delivers an ever increasing standard living. That said I will always look for monopolies to invest in where I can find them at reasonable prices. You have to somehow deal with the unfair world.

Tyler Cowen adds:

Maybe political risk is the worry.

If the market is pricing a Monet painting, or a forest, it seems quite well to account for the services yielded decades into the future…
 

Apr

15

 I offer the following question only because I would appreciate constructive criticism.

Free markets work well for short term investments, such as publicly traded commodities and equities. The free market falls down in long term investments because they lack liquidity and price discovery for investments lasting 5, 10, 15, 20, 30, 40 or 50 years.

How is a utility to finance capital improvement projects under such circumstances? I'm finding every investment organization I've talked to is unwilling to participate in a US deregulated power market asset because they cannot hedge their investment.

Today, few are financing power plants in deregulated regions because there is no bankable offtaker. The result is few power plants are being built in these areas.

What is the Austrian School's take on this challenge?

Thank you for considering the question.

Henry Gifford responds: 

As for deregulated electricity markets, I think what is currently called "deregulated" is different from what I think of as free market. I will use the California deregulation as an example.

When California deregulated the electricity markets, they formed three new state government agencies, one with monopoly power to sell electricity at the wholesale level. I have no idea what the other two did. The agency signed long term sale contracts with local utilities, and bought electricity from both in-state and out of state (California is a net importer) suppliers on the spot market or on short-term contracts. I repeat - they signed short term purchase contracts, and signed long term sale contracts for set prices. The agency made a few billion dollars of profit in a few years, as buyers were barred by law from buying from anyone else (remember, I am describing deregulation), and the state bought for a lower price than they sold for. The inevitable happened - short term prices rose above the prices they had contracted to sell for. The state government did the inevitable: they passed price control laws, barring their suppliers from selling at a price that would be unprofitable for the state government (remember, I am describing deregulation). Out of state suppliers refused to sell at the lower prices, so the California governor asked the president to pass price controls for suppliers outside of California. The president did not do this. Meanwhile, suppliers went unpaid. I repeat - the state agency did not pay for what they had bought. Instead of paying, the state demanded to first investigate their allegations of "unfair profits" while the bills went unpaid. As out of state suppliers who were owed money were getting investigated, they refused to sell power to the state, and the lights went out. (repeat: I am describing deregulation). This gave deregulation a bad name for a generation, spawned the usual anti-freedom documentaries, and because the arrangement was called deregulation, free markets were also given a bad name. But, I don't think a government monopoly is a free market, and have never met anyone else who does. Instead, people just keep calling it deregulation and saying deregulation doesn't work, and the free market doesn't work, including many people who know the deregulation involved formation of monopolies, price controls, etc.

Now if you reread the description above, and think of the position you would be in if you were a producer of electricity in California, or were considering becoming a producer, or financing a new power plant, your lack of enthusiasm would be understandable, but have nothing to do with failure of what I think of as free markets, long term or short.

The statement that free markets fall down in long term investments is I think inaccurate. Lack of liquidity is priced into investments that are difficult to sell.

I don't know what "price discovery" is. Real Estate is rather illiquid, but prices for most transactions are a matter of public record, and advertised prices for comparable properties are always available.

I would invest in an electricity producing plant in California if I thought the price was right. With some looking I would tell you what that price would be, which I think indicates there is no lack of price discovery for long-term investments.

 

Dec

8

 Hello everyone,

I'm at my local lumber yard and a salesman for various materials is here and stated that on the first of next year all drywall manufacturers are increasing their prices 35 per cent!

That should really help new homes built and all remodeling… and all commercial jobs.

Regards,

Alan

Rocky Humbert writes: 

Firstly, I'd like to thank Alan for bringing this to my attention. This sort of anecdote can have some important market significance. However, in order to analyze it, one needs to ask the following the questions:

1. What is the marginal cost to produce drywall? How does the current (and proposed) price compare to the marginal cost of production?

2. What is the price history of drywall? If the price has previously dropped steeply (due to the economy), then a 35% price hike (although eye popping) might be reasonable.

3. What are manufacturer and lumber yard inventory levels? Could the announcement of a 35% price hike be an attempt to front-load orders/purchases before year-end? … to clear out inventory?

4. At what % of utilization are drywall plants currently running? Has capacity left the system over the past few years? And if so, at what price will that mothballed capacity come back online?

I think an ambitious spec could call US Gypsum's investor relations office with these questions; get the answer; and have a better understanding of both the drywall market; the state of the housing market; and the state of the economy. I think there is also some risk that this 35% price hike could stick — not because the economy is healing, but because productive capacity has left the system ….and will not return until growth is considerably higher. This is the stagflationary outcome that some people fear….

The bottom line is — a few well placed questions and answers will turn Alan's anecdote from dinner party chatter to an economic/market insight.

Henry Gifford writes:

1. Energy is a significant part of the cost, as is shipping the materials and shipping the finished product.

2. I dunno the price history.

3. In urban areas, there is no significant inventory - the stuff just takes up way too much space. For jobs involving multiple apartments, or one large house, the lumber yard is not really a dealer, but more of a broker, as the boards are "drop shipped" from someone else to the job site, only the money goes through the local lumber yard. Maybe in Alan's neighborhood they can build up significant stock, though.

4. Someone in the business told me all plants generally run at full capacity all the time, including through downturns, because during a downturn they take their slowest plant and shut it down and revamp it with the newest electronics to become their fastest plant, restarting in time for the next boom. He said with a smile that they never worry, the timing is always reliable - boom and then bust. They haven't added any new plants in decades, they just speed up the old ones, like the paper industry has done to keep up with the "paperless" office.

There is really no substitute for gypsum board on the market - no boards means no new houses or other buildings.

The industry is now shifting to "paperless" gypsum boards - fiberglass instead of paper - because of increasing mold problems with paper-faced boards. Buildings are starting to get significantly insulated, which means walls have a cold side in the winter, and a cold side in the summer, and cold means damp, which can mean mold. Also, backup materials used to be masonry which absorbed a lot of water from leaks, then were wood, and are now metal, which absorbs zero, meaning a small leak gets to the paper and causes problems. Combine cold and no absorption/storage with no attention to stopping air leaks in construction, you build a recipe for disaster, not all just insurance or hysteria driven rumors. If anyone invented paper faced gypsum boards now, the lawyers would never let them sell it. I expect it to all be gone soon, the changeover will be "interesting" somehow.
 

Aug

31

 How I have missed you. It occurs to me after a few days without power that nothing in our modern world works without electricity. I suspect power generators are much more valuable than the market gives them credit for.

Henry Gifford writes: 

Electricity is priced in a strange way, and generally thought by many to be heavily subsidized.

Roughly described, the utility company is guaranteed a % return on investment, so once a wire or power plant is paid back, it is "a sunken cost" and carried on the books as worthless.

Residential customers pay only for buying and transporting electricity they use, and for political reasons pay nothing for unused infrastructure. This is a little like telling a taxi to wait by your door all year because you might want to go someplace on New Years Eve, or you might not want to go anyplace, but you won't pay the taxi to wait at the curb all year.

"Commercial" customers pay a "demand charge" for the infrastructure capacity that is available 24 hours 365 days per year, but only fully used for a few minutes per year, often in the late afternoon in the summer, when everyone else wants it. The demand portion of the bill can exceed the electricity buying and transporting charges, and indeed many companies are in the business of helping large users shave their peak demand, sometimes by shifting it to a non-peak time.

One example is the 20+ companies in the US that manufacture ice storage tanks. Customers with large air conditioning loads make ice at night, when their demand is lower, then use the ice for cooling during the day, reducing their peak (daytime) electricity use.

Charles Pennington clarifies: 

We're categorizing water in three ways: drinking water, washing/cleaning the body water, and flushing-the-toilet water.

Sam's Club Diet Lemon-Lime Soda is a pretty good go-to for the washing/cleaning the body water. It's cheaper than most bottled water, and because it's "Diet" it has no sugar and is good for washing your hands. I guess it's not optimal for brushing teeth, but it won't be for long, I hope.
 

May

1

 Has any one commented on the subtle reasons that the accounting firm that made the audit report for Berkshire on the Sokol trading did not ask him one question or have one meeting with him before the report? There must be a legal reason for this. But to the layman, it would appear to be that they were afraid of having to report his response.

Henry Gifford comments:

An apartment house was built in Manhattan with parapets (those brick walls at the perimeter of the roof) which leaked so much water into the apartments they were removed and replaced at great expense. The architect was one of the people sued. The architect pointed out that the contractor did not build the parapets according to the plans, thus the architect was blameless, and was dropped from the lawsuit, and was not further involved in the next two removals and replacements of the parapets in further efforts to remedy the problem.

Perhaps the architect could have been asked to refund the fees paid for supervision of the work, but nothing more.

Numerous people hired to do designs in the construction industry advise never physically going to a construction site, thus there is no responsibility for defective work.

It would be interesting to know the physical location where the auditor's work was done, and to know if there are any standards of conduct that require a visit to an office, a visit to a business if the work exceeds a certain size (such as the business I once visited that looked very prosperous until I noticed the phone almost never rang), seeing originals of documents, seeing documents while no other parties are in the room, having documents in possession for a certain period of time before a report is due, or if all work can be done remotely based on copies of documents faxed over few minutes before the report is due.

Rocky Humbert writes:

The Chair writes: "…subtle reasons that the accounting firm … did not ask him one question or have one meeting…"

From a
partner of Munger Tolles & Olson (a very large corporate Law Firm (not accounting firm) which represents Berkshire):

"Mr. Sokol was interviewed at least three times regarding his Lubrizon trading activity and contacts with Citi bankers. In connection with the preparation of the audit committee report, a request for a further interview with Mr. Sokol was made to his attorney. Mr. Sokol was not made available."

On the advice of his attorney's, Sokol stopped cooperating. What's subtle about that?

Victor Niederhoffer writes: 

There's nothing funny about that. What's funny is how the attorney for Mr. Sokol said that "without the care and deceny to ask even a single quetion of Mr. Sokol". Only two lawyers or Sholem Aleichem could show how both lawyers could be right in what they say.

Rocky Humbert adds:

A little talmudic interpretation may help:

Sokol's lawyer wrote: "I am profoundly disappointed that the Audit Committee…would authorize the issuance of its report to the public without the care and decency to ask even a single question of Mr. Sokol."

This is semantic deconstructionism worthy of Bill Clinton's the meaning of "the".

Sokol's lawyer didn't say that the Board didn't ask him questions. It says that the board didn't ask him questions about the issuance of the report! 

Stefan Jovanovich writes:

Has no one heard the joke about the lawyer, the accountant and the engineer trapped on a sand bar surrounded by tiger sharks with the tide coming in– the one with the punch line of "Professional courtesy"? What else would 2 lawyers say? The R-Man is nearly infallible; but he is wrong about Charlie Munger's firm being "very large". In the world of bulk word carriers, it is not even a PanaMax.

That does not prevent MT&O from preserving its reputation for Janus-like integrity. Before we surrendered our tail fins as LA lawyers, Eddy's Mom and I used to play a game of identifying the local law firms by show tunes. From Day One MT&O was always matched with Kurt Weill's signature tune.
 

Apr

24

 I just did a quick read of Fisher's Crashes, Crises, and Calamities: How We Can Use Science To Read the Early-Warning Sign s. Although I found it to be light on applied theory, I thought some of the general ideas put forth in it were worth some additional investigation.

He discusses the impact of negative and positive feedback on systems. In really simple terms, negative feedback is generally a stabilizing influence on a system but it needs to be applied quickly as a series of rapid small changes versus a larger more gradual one, and positive feedback near a transition point can cause a system to suddenly change states.

One of the more interesting phenomenon he talks about is the Allee effect in which a population can grow if it is above a certain level, but will enter freefall if it is below that cutoff density. He talks about a problem with flamingos breeding at a certain zoo due to this effect which was alleviated through the use of mirrors to give them the illusion of a higher density.

One of the other areas of interest is the idea of resilience in systems, and the fact that it is the loss of it that leads to rapid state changes in systems as they are more easily pushed through a tipping point. Loss of resilience leads to a system that is slow to recover from an initial assault, and less able to maintain equilibrium after a subsequent one.

He argues that there are 5 key early warning signs indicating a loss of resilience:

1) Increasing occurrences of extreme states

Fluctuations near a critical point can drive huge jumps between alternative states.

2) Fluctuations between different states

3) Critical slowing down

A progressively slower ability to recover from small perturbations as a crisis approaches. Under this section, he mentions Parkinson and his concept of injelititis as a disease that brings down companies. Parkinson's Law and injelititis are a subject worth an entire discussion on in their own right:

4) Changes in spatial patterns

5) Increasing skewness in the distribution of states

He also spends some time on Toynbee and his idea of the life cycle of societies corresponding to a musical rhythm of three and a half beats to the bar. This plays out as a period of initial growth followed by some event that marks an end to growth, and then a three and a half beat pattern of collapse…recovery…collapse…recovery…collapse…recovery…final collapse.

Overall, I found some interesting food for thought here.

Ralph Vince adds: 

Interesting post Dylan, thanks. I would add to this, though, a very simple amendment note– crashes in commodity prices are most often preceded by a contraction in open interest. 

If, in the midst of a price run-up (typically, what we would call a "parabolic-style" run-up, and OI begins to roll over (because a run-up is typically seen with expanding OI), as OI decreases and the price continues its rise, it's about over, and likely to come down symmetrically with how it ran up. I am speaking only of hard commodities here, not financial ones.

Henry Gifford writes:

This is similar to my old trick of watching the thickness of the multiple listings book to gauge interest in real estate, now there are gauges such as average time between listing and sale of property, etc. Proxy for OI.
 

Apr

17

 The op/ed page of yesterday's local rag noted that our utility company, a well-run organization with a penchant for developing alternative sources of power, would install solar panels to light a downtown park. These are not your run-of-the-mill static panels, they're axially mounted, so can articulate to capture max sunlight. Pretty nifty.

The utility company will pick up the entire $25k-$30k tab, including the install, operation and maintenance. Sure, they admit this is pocket change for them, it will promote the company and its mandate of developing cleaner energy sources, and they hope the visibility in a prominent location will inspire private enterprise to invest in other similar projects.

On the other hand, estimates are the city will save between $550 and $700 per year in lighting costs. Always cool to save some money, but in this case, the city pays the utility company less because of a system the company installed and paid for. So, by investing in the solar system, the utility actually loses money up front and on an ongoing basis. Sounds like health care economics.

But, let's assume for a minute we don't care about who pays for what and do some math. Rounding for convenience, we have a $30k cost divided by $600/yr in savings, i.e., the breakeven is 50 years.

Whoa! Fifty years! As a guy who learned 'guns and butter' the first day of Econ 101 and has lived by that principle almost religiously ever since, I'm trying to wrap my arms around this.

It's kinda like trying to justify the purchase of a Toyota Prius. No matter what, over the life of most cars, if one buys a vehicle of average cost that gets reasonable mileage, you can't make up the difference in purchase price with the savings from reduced fuel consumption. So, you pay more up front and less in the long run, but your reward is psychic, 'cause overall, you're paying more to get around than in a conventional vehicle.

The state of technology today is such that, two years ago, I turned in my expensive 21mpg leased SUV, bought a low-mileage off-lease 33mpg upscale wagon w/ a certified warranty for less than half the price of a Prius, and haven't looked back. I figure an immediate 50% increase in mileage and concomitant 37% decrease in fuel costs are pretty good returns. Reduces my operating costs and I get to help with the problem of limited oil resources without doubling my cap cost to buy a Prius, which would leave me with much less to blow on other goods and services. So, the choice was a win-win for me and a win for the greater good.

Thinking on, one begins to wonder why we are willing and able to justify spending exorbitant amounts of money on luxury items that are essentially meaningless, when we're not able to justify the same sort of over-expenditure on an item that might actually produce a return of some sort, like the solar install in the park.

Take Rolex watches, for instance. It makes absolutely no sense to me to spend $10k on one of those when it does not tell time one iota better than does a Seiko Premier with a $375 street price. And, I know better to accept the argument that it has an automatic movement [Seiko Premier's kinetic mechanicals are some of the best around for the price], that it's hand-made [Rolex makes a million watches per year. Handmade? Sure, some of their very best are, but these are not all individually hand-crafted items to be sure], or any other of the standard technical arguments.

The truth is, when one buys most any second tier luxury watch, more than half of what one pays for is hype. And good bit of the remainder is simply the jewelry value of the watch.

And, there it is. The whole deal in a nutshell. It's about value. We spend our money on what we value. Some value glitz. Others value cleaner air. Both fair propositions. Frankly, I value a fat bank balance far more than I do stuff. If I'm going to spend, I'd rather spend on seeing some part of the world I haven't seen yet and on making a memory than on hard goods. And, I'm almost always happy to exchange a physical asset for $$$$. Not everyone's built that way, but that's what makes the system work.

What's more is that system is capitalism. Capitalism it isn't about Ayn Rand. It isn't about heroes and villians, nor about big business versus the common man. It isn't about government interference, taxation and sharing the wealth.

Capitalism is about our ability to value the capital we have and exchange it with another for something else we value. A free market enables each of us individually to define what that value is and exchange it unencumbered. It's capitalism that allows us to spend or overspend if we choose, and it's what gives a utility company the ability to spend $30k for a $600 annual return inuring to someone other than itself and a 50 year breakeven if that's what it chooses.

Unfortunately, the simple idea of capitalism is too often intermingled with the ignominious behavior of high-profile market actors and con men, giving the impression the system itself is undesirable or so flawed as to require a heavy hand rather than an invisible one. But that impression is simply misguided.

What's wrong with capitalism is the same thing that's frequently said about democracy……."it's messy." Yeah, it is. And, it's imperfect, but all things considered, it works pretty well and it's just too damn grand for words.

Stefan Jovanovich writes:

In my not so humble opinion, David has explained beautifully why the authors of the Constitution had an explicit prohibition against direct taxes. Allowing the tax code to favor particular transactions over others undermines liberty itself.

Henry Gifford writes:

The numbers in the article are probably not accurate. In my experience, solar electric systems have an ATR (Average Truth Ratio) of about 10. That is, actual payback is about 10 times reported payback.
For panels that do not move to follow the sun, the cost (according to sharpUSA, claimed largest supplier in the US) is about $9 per installed Watt of capacity. What is a Watt of capacity? One Watt at solar noon, less at all other times. Maps of annual noon-equivalent sun hours stopped being published about 30 years ago, but for the 48 states, 1,200 hours per year is a rough optimistic value, yielding about 1,000 hours when losses in wires and electronics are subtracted. Utility companies call one Watt for 1,000 hours a KiloWattHour, and sell it for 9 cents (2007 US average), yielding a 100 year payback.

But, this is not even realistic, as it assumes perfect angle and perfect orientation and zero shading.

Real world, imperfect installations have much longer paybacks.

And, the above figures are for estimated production, with measured production typically at least 20% lower, even if installed perfectly. Finding data on actual measurements is almost impossible.
Some well known and frequently photographed systems had problems being connected, and were never even connected electrically, yet still produce grant money and publicity year in and year out.
Fancy systems that move to track the sun have mostly been abandoned as even more costly and too complicated and unreliable, although the claimed yield is higher.

Back in the real world, solar thermal systems that make some, but not all of a building's domestic (faucet) hot water have much better paybacks, and an ATR of perhaps 3 to 5, although assessing yield is much more complicated, as it requires assumptions regarding hot water use volume and patterns.

 

Mar

30

 One played a game of checkers with someone likely to be a front runner for president in a few months, and we discussed the importance of Tom Wiswell's proverb "moves that disturb your position the least disturb your opponent the most". In checkers, I think it means not to break up your foundation, not to have too many infiltrator single men far removed from the bulk of your pieces. Not to have too many holes in your position. Not to have too many of your forces divided by big spaces. Maintain your dike which is a solid row of checkers on a diagonal of at least 4 or better 5 or 6. In general, make sure you have near neighbors for all pieces. I got to thinking how this applies to markets. It seems very applicable. Don't put all your chips at one price. Do things on a scale down or up. Don't move into other markets with big positions when you have the bulk in one position. Keep your positions at approx the same size. Don't throw all your chips in at a certain time, but gradualize into positions. Don't get out at close or in at open. Maintain a constant capital stream. Be humble.

What else would you say? How would it apply to life? Don't move into new investments unrelated to what you do without much reflection and gradualization. No staccato in your movements into your second childhood? What else?

Anatoly Veltman writes:

To add: a grandmaster can't use the same sole opening pattern all the time. High level competition will adopt– and they will no longer be disadvantaged. So while it's important to stick with your successful patterns– see if those patterns can be validated for situations arising out of a different opening sequence.

Nigel Davies writes:

I agree with Anatoly. Actually I've often given up opening systems at the height of their success; waiting crocs plus loss of vigilance etc.

Jordan Neuman writes: 

There is a similar thought in baseball strategy. In a situation where one's move will lead to countermoves, it is sometimes best to do the opposite of what your opponent wishes you to do given his perception of his own countermove options.

This is all under the general category of putting yourself in someone else's shoes. I find it very easy to see where others have messed up their or their children's lives. I would say my "win percentage" is much higher in those cases, prospectively, than in my own life. Perhaps the Wiswell proverb describes depersonalizing decisions as a way to make them less emotionally difficult.

Henry Gifford comments: 

Regarding the above about ruining the lives of one's children, my uncle used to say he ruined the life of his son, who was a heroin addict.

Looking at what he said from the other side, if what my uncle said was completely true, then parents have the power to stop their children from doing drugs or partaking in other ruinous activities, something many parents are frustrated to know is not true.

This perspective can ease the pain in some situations in life, and maybe in trading losses also.

Allen Gillespie writes: 

On the violin to play fast one must leave fingers down for the return.

Feb

28

 A couple of weeks ago, The Chair discussed a dinner he had with Dimson — and that Dimson noted the "long term rate of return for everything other than stocks" is around 2.8%."

This morning, Steve Landsburg articulately expanded upon one of my points regarding utility value– demonstrating that headline numbers regarding long-term returns can be horribly misleading. In particular, he addressed James Glassman's recent WSJ op-ed where he admits that his Dow 36,000 call was wrong. But importantly, Glassman's mea culpa was wrong for the wrong reasons.

Landsburg's essay reminds me of the adage: "There are sardines for trading. And there are sardines for eating.

Duncan Coker writes:

I have known a number of developers as friends from having once lived in a resort town. During the go years when they would sometimes present a deal to me for a small share, I would point out the implicit 5 to 10 times leverage, or the large share of sweat equity they usually wanted. They would always look at me like I was an uneducated amateur who did not understand the main unspoken premise of building. Build it and they will come is always the motto, and you do have to admire their optimism.

Kim Zussman writes:

"The truth is that stocks appreciate faster than houses precisely because a house does not just sit there; it provides shelter, warmth, and closet space every single day that you own it. Stocks need to appreciate faster to compensate for the fact that they don't provide any comparable stream of services. If stocks and real estate appreciated at the same rate (counting the dividends as part of the appreciation, as Glassman does), nobody would own stocks."

Margin issues notwithstanding, very few would choose homelessness to be in the stock market. A better comparison would be a rental house held as an investment - where the shelter utility is capitalized - vs (initially equivalent value) investment held in stock(s):

Over time, stock will pay dividends (or reinvest earnings, etc), and the investment will grow by capital appreciation + dividends Over time an investment house will pay rental income, and the investment will grow by appreciation + rental income - upkeep

The Case-Shiller home price index shows real house prices approximately flat (with considerable variability) over the past century, whereas the stock market is up. It would be interesting to compare rental property - including rental income - to stocks over the same period. In theory rentals should go up more, to pay for the aggravation of being a landlord.

Henry Gifford writes:

An important factor usually left out of such discussions is that houses can be bought on 80% or 90% "margin," with fixed interest rates, in effect, being a giant option on the US dollar, favorable to the real estate owner in times of inflation, when real interest rates can be negative.I think this is how most people who make money on real estate make money on real estate, although few talk about it this way. 

Feb

22

 The more one studies the markets, the more one is convinced that the hallmarks of a con are very useful in unraveling the possibility of making a profit. In this regard, I found the article "Con Ed" which features the insights of Todd Robbins, where he talks about spotters, the 3 h's of cons: hide, hype, and hate, and the direct relation between misery and the extent of cons to be helpful. I find that prices often have the hallmarks of con when they break through a barrier, showing you that it has overcome a difficult hurdle, and thereby gaining trust and confidence. Also, the spotter, the person that makes you confident by showing you his trust in the deal. So many CEO's, analysts, and newspeople play that role.

The article features the common adage that you can't cheat an honest man, or the related it's always the greed of the mark to get into something with an unfair advantage as a important precondition. How much evilness lied in most of the victims of the Catskill, Palm beach, Riviera, Long Island con who all must have thought that they could front run the market making operation downstairs. The importance of giving the mark excessive praise, which in most cases would be a short term profit, and is related to the principle of ever changing cycles would be another one.

The whole subject of flexionicism as a variant of the big con needs to be studied and quantified.

Sam Marx writes: 

The missing data for such a study are the successful con games that are never discovered.

There are probably a load of Ponzi schemes still operating.

In fact a Ponzi scheme, with luck and some skill, could turn out to be a big winner for both the manager and "investors", especially in a bear market.

In a successful classic con game, at the backend, there is what is known as the "blowoff" where the victim has lost a bundle, doesn't realize he's been conned, and actually is convinced he has to keep quiet about it or he'll wind up in jail.

Henry Gifford writes:

My favorite book on cons is The Gentle Grafter, a collection of O'Henry's short stories on the topic.

Many entertaining scenes of con artists arguing over whose specialty is more moral and noble, and the entertaining justifications they come up with, meanwhile constantly conning each other.

George Parkanyi finally asks: 

What is a flexion anyway? I see the term used here liberally, and it seems to have nothing to do with the dictionary definition (which has to do with bending limbs). And is "flexionic" even a word?

Gary Rogan elucidates:

This is Victor's explanation:

From the book The Shadow Elite by Wedel, Ganini. Former fed officials. Former high treasury officials with private access to the sqaush courts and executive dining room. Presidents of colleges, former and current, who worked at high positions in the treasury and fed staffers privy to the daily conference calls at which all upcoming releases are discussed high executives on Wall Street, who are consulted about the economy for their feedback by the treasury and the fed. Big owners of newpapers from Nebraska who dine on coke and dairy cream. Counterparts and their operaitve from other central banks that our treasury and fed discuss the upcoming policies and release with on a need to know basis so they will not be surprised and will know how to act and put things in perspective for their flexionic pursuits a home. Operatives within the agencies that prepare the numbers and especially those who make final adjustments on them.

Rocky Humbert writes:

I agree that unquestionably, and right under everyone's noses here, absent the savoir vivre of Madoff, that there are many Ponzi schemes still operating. One good whoosh will shake them out here (I am aware of one which I am certain of, massive in size, and I can only laugh that this one is still out there prowling in the deep).

Unlike Madoff, these other funds are not primarily comprised of Jewish investors (in truth, Madoff did have some Arab soverign wealth fund money too, but the majority of it was from the Jewish community) so when these monsters explode I would look for an entirely different reaction this time.

We were speaking of cons on a previous thread in a related list. I predict after this next manager explodes, the investing world (not necc "the public," we're not talking about hoi polloi here) will wake up and realize that if the manager has access to the money– it might be a con. Managers do NOT need access to the funds.

Sam Marx adds: 

I believe that it was in Barton Biggs' book Hedgehogging that Biggs described a club of money managers, large investors, etc. that he belonged to that would share financial information unknown to the public. But if anyone related information that was to the divulger's advantage and detriment to the divulgee (new word?) the divulger was blackballed.

Would this be considered part of the "Shadow Elite"?

Dec

22

 One notes that:

1. NY Commuter rail fares will increase by more than 11.1% on December 30th (for the Harlem and New Haven lines.) 

2. NY Commuter rail fares will increase by more than 14.3% on December 30th (for the Hudson line).

Assuming a brisk walking pace, a Westchester County resident can make this round trip trek in about 12 hours. In contrast, a round-trip peak ticket costs $28.50 and train-station parking costs $6.50. Hence, a day-trip into Manhattan costs $35.00 per person. Assuming a 40% marginal tax rate (State & Federal Income Tax), the pre-tax cost becomes $58.33. This is about $4.86/hour.

It's therefore a relief to know that the New York State Minimum Wage is now $7.25/hour. So it still pays to work.

Victor Niederhoffer writes:

One would have to adjust Mr. Humbert's calculations based on the age distribution of the population. "One senior ticket and one child," Aubrey always says when the conductor comes. That's Keely's 7 bucks for me, but my walking pace has slowed, (as witness my failure to pass the California test for the DUI). Say I am at 3 miles and hour. It would take me 17 hours to get to Manhattan for my 50 miles. (I believe Elonra Sears, the lady squash champ, would do it in 16). If my time is worth more than 50 cents an hour or so, it pays to take the train, assuming I would not make losing trades. (In the past, when asked to do chores, I could always tell Susan, that the chore cost me 1000 or 5000 an hour when I could make money with impunity, but now that doesn't work and Susan often says that I'd save money by washing the dishes or changing the light bulb, or shoveling the snow.)

Russ Sears writes:

 A couple guys come to mind when you talk of going 50 miles a day to work.

Legend has it that Bill Rodgers headed for nowhere, working in a morgue delivering bodies, when his motorcycle was stolen. He started to run everywhere. This helped him to start running again after stopping after college track. He also was smoking before this. And he is the only guy I have heard of that doing more than 150 miles per week actually strengthen him. He topped out at 200 miles per week 16 in the morning 13 in the evening.

The other guy is Dr. Horton, who was a Phys Ed Professor at Liberty. He set the record for running the Appalachian Trail. He averaged I believe, near 50 miles per day. He had line up Churches to help him throughout the course. He would meet them at points most nights, so he could eat hardy and sleep and then next morning drop him off at the same point. It was getting to the meeting points that added to the distance to the 2,200 mile course. (now I hear 2 other guys have broken his record of 52 days) This was very tough on him and I heard from my CC coach that it took him over 2 years to shake the mental depression such distances placed on his mind and body.

At 50 miles: plans would have to be made to have plenty of liquids along the way some light food. then latter eat and eat hardy and well. A mile burns roughly 100 calories, for average weight guy. Plus the normal 2000 calories, would require about 7000 calories a day. Phelps is said to eat 12,000 calories a day.

One summer in college, I lived on a nickel to save for the next years tuition and road a bike near 30miles a day for a couple months to work. 100 mile days are normal for serious bicyclist.

Henry Gifford writes:

I used to compete in and win, 24 hour bicycle races– ride as much as you like, rest as much as you like. Some wimps even took naps.

At the level we were at, consuming enough food was a deciding factor during a race, and buying it was a major expense, for a race and at all other times. One year someone handed me up candied pineapple, which I had never eaten. I barfed, but still rode as hard as I could, but I was like the car in the Indy 500 with the torn gasoline fill pipe from a sloppy pit stop exit. I was able to keep up, but couldn't  refuel, surely coudn't have finished or won.

Someone helping run the team knew to feed me boiled potatoes, after which I was good to go. I ate everything on the next lap around. 

Larry Williams wrote: 

I also found boiled potatoes to be the key, with salt, to correct food for ultra marathons.

Jun

2

 Reading through Linchpin by Seth Godin advocates getting away from the quantified.

We measure the quantified because we can. But we should create the unquantified because it's so rare. If you can quantify it, then probably someone before you figured out a why to grind it out. And if you can grind it out, someone can grind it out cheaper than you can. On the other hand, the really valuable stuff, the stuff we pay a lot for, is unquantified. Things like creating joy or security or happiness. No easy measurements for those, thus they are art, and art is always worth more than the predicted.

Henry Gifford comments:

Similar situation with how much energy a boiler takes to heat a buildng. The quantifiable is the least important– the % efficiency while the boiler is operating (% of energy in fuel not going up the chimney, but going into heating the building).

The second most important thing is quantifiable enough to have % numbers on it, but those numbers are hopelessly inaccurate– the annual % of the energy in the fuel not going up the chimney (different from above because of the heat going up the chimney from a boiler that is hot, but not firing). Most of this loss can be avoided, but nobody bothers because the % ratings don't change with improvement.

The most important thing is so hard to quantify there is not even a unit for it– how unevenly the building is heated. The chair helped me put some units on this once, but otherwise, I have never even heard it discussed in my field. Uneven heating means overheating the whole building to satisfy the coldest room, with the overheating costing much more energy than the factors mentioned above.

So, in my field, everyone is running around measuring the least important factor, while the most important factors are not even discussed.

One solution is to focus on solving the problems, (short chimney, thermostat in every room) without being able to predict the resulting saving. But, without prediction, it's a very hard sell. Good for one's own portfolio, harder with other people's portfolios.

Peter Grieve adds:

When people are making purchasing decisions in areas in which they are not expert, there is a strong tendency to reduce things to a few numbers. These numbers are easy to compare, but present a grossly simplified picture. The simplest machine has myriad degrees of freedom, and so does the operating environment. The assessment of the interaction of these two cannot be crammed into four of five numbers.

This is especially true in government procurement, for example weapons systems. The M4A1 carbine is supposed to have an effective range of 300m. I have done a lot of shooting with the civilian version of this weapon, and I can assure you that this one number does not capture much of the essence of the range of the machine. On a hot or cold day? Shot by a master or a bumbler? Standing or prone? Against armored or unarmored targets? Shooting from sunlight or shade?

But this number is easy to compare with corresponding single numbers of other weapons.
Or take chess ratings. Chess strength is a very complicated thing, which cannot be reduced to one number. There are cases in top level chess in which A does well against B, B does well against C, and C does well against A (Nigel D. can help with examples here). Single real numbers are linearly ordered, and no three of them can satisfy A>B>C>A. Single real numbers are not adequate to encapsulate chess strength in its entirety.
 

May

20

sotheby'sA daughter webmasterist asked me how pools signal to each other to stand aside on auctions and not get into bidding wars so as to lower the average net price that you get with high quality goods from auctions with the majors to about 50% of the current market value. I didn't have a good answer except to say that it's the invisible hand. The big dealers partner on deals, and they decide in advance who's going to buy it. With that one big dealer the only presence the competitive elements is withdrawn. Also, if a non dealer customer comes in the dealers know what's good and what's bad. And how much to bid. And they often tell the customer that he'd do better buying from them without the hurly burly of having to wait a few hours while the blue bloods in their monotonous voice try to eke things above the reserve.

She then asked me how this is done in the markets. And again I didn't have a good answer. Some of them have dinners together, others go on the media to tout, and others ride in a car together or tergiversate who's weak and where the vulnerabilities are. Often it's a pilot fish in a peripheral market that's not so obvious like the fixed income vis a vis the equities.

But I didn't have a good answer like Dickson does in his baseball work, i.e. the hidden signals, and the changing nature during the game, as to the code, and who's giving it? What would you have said so as not to disappoint a daughter with one's naivete?

Henry Gifford writes:

I know of at least two ways cartels do this.

My mother used to be a licensed auctioneer, having done a few charity bits and wanting to be legit, which ended her up on the list for doing auctions for the city government. At the Dept of Sanitation auctions where she auctioned off contents of apartments that had been stored by the landlord for the required time period before auctioning, the boxes were sealed, but the Dept of Sanitation employees tipped off the cartel to which lots were good. The cartel bid a minimum and then held their own auction on the hood of a car outside. Each member put the cash on the hood as he won a bid, then at the end of their auction the money on the hood was split evenly between the cartel members, about 5 or 6 of them. One time one guy was in the hospital, sent a messenger with a low bid for one lot, which he didn't win, but he was eligible for his cut of the auction profits, delivered to him in his hospital bed. If an outsider showed up at an auction, everyone bid against him at a cost shared by the whole cartel if they won the bid, and encouraged him to win the bids on the crummy lots. If someone showed up saying it was their personal goods for sale, they did a "courtesy bid" and let them buy the stuff for $10. At the police auctions, the jewelry was not in transparent plastic bags, but in translucent bags which bidders were prohibited from opening to examine the goods. Insiders, of course, knew which were the diamonds and which were not.For public bidding on contracting work, it works a little differently. One scheme is a cartel takes turns assigning jobs to members, who are told how much to bid, and which jobs they will win. They are asked to bid high enough to lose on some, etc. This requires cooperation from the agency putting the work out to bid, to discourage participation by outsiders. This can take many forms, including "confusion" about the time and place of the bid opening, or simply waiting until two weeks after the bid opening and mailing the bid back with a note that it was late. As money paid to purchase plans and money spent to put together a bid is not trivial, a few experiences like this can discourage someone from bidding - my personal experience.

Another trick is to put out work worth about $100K and mention a $50K contingency fund for unforseen site conditions, unknown soil conditions found only after digging, etc., confusingly written, so if an outsider wins they are told their bid is to be reduced by $50K, while insiders get $50K added to their bid.

Or, heavy duty mechanical work is mixed with painting work, which contractors who lack housebroken workers are hesitant to bid on, thus only one or two friendly contractors bid, and maybe bid high to cover unforseen adventures with painting. Another variation is asking for a very expensive, special piece of equipment, which insiders know they can skip installing, while outsiders are held to the terms of the contract.

This puts the systems into two broad categories, as far as I can see:

1 Better information for insiders 2 Rules are different for insiders.

Number two was perhaps covered on the list when some firms on Wall Street were bailed out, leaving us mostly with what was described below as rides in cars together, etc.

When I can't avoid being near a radio which is playing, I am reminded of this when I hear "company such-and-such announced some problem, the stock fell x points today", of course telling me what is told on the news is not news any more, and there was someone getting the news ahead of time.

I used to own a newsstand, and get the Sunday NY Times Real Estate section on Thursday night, which led to some good real estate deals for me. But, otherwise, I don't know of any legitimate way to get any such advantages.

Alston Mabry writes:

At auto auctions, if the guy running the car has an in with the auctioneer, then you gotta watch out and make sure you're not "bidding against the wall", as they say. Crowded conditions make accurate observation difficult. 

Mar

4

The Ring of FireEarthquakes are an interesting analogy for how markets sometimes move. Correlations may be stable for a time, as they have been for the past couple of months, but then a sudden tectonic shift can either break a given correlation or maintain it but cause a sudden shift in differential between the correlated items. Case in point, Monday the first of March. I have ¾ of my trading assets in USD (alas), and have to suffer the constant currency hit when oil and to a lesser extent, other commodities and equity markets go up. It’s been like clockwork for quite some time. On Monday, oil and other commodities were down significantly, the USD up. The Canadian dollar should have been down as well (mitigating the other declines, to my advantage) but instead went roaring the other way by over a full cent — the reason being an upbeat GDP report from Canada. Needless to say I took a relatively outsized hit in CAD terms that day. The next day the correlation returned to “normal”, but the Canadian dollar had shifted to a higher relative position against the US dollar – a sudden tectonic shift in differential as it were. (A similar analogy from physics is how particles jump from one quantum energy level to another without any smooth transition in between).

The markets then have their own “ring of fire”. Earnings announcements, takeovers, devaluations, surprise government rate and policy decisions, crop reports. These are the risks of living in sunny market climes. They can be more or less managed if you build your portfolios to “code”, but once in a while such an event (e.g., the subprime crisis) can spawn a killer tsunami (the 2007-2009 bear market/“Great Recession”) and severely damage even a well-constructed portfolio. And the portfolios built by crooked contractors that cut corners (Madoff); well those are completely shattered and washed out to sea.

What’s your portfolio building code? And where’s your high ground?

Henry Gifford comments:

Building codes follow Bacon's law, both mandatory codes and voluntary standards.

The changes are partly in response to lobbying by manufacturers of products, partly in response to new technologies becoming available, partly due to changing politics/wealth levels/societal interests such as handicapped access and the spread of mandatory fire sprinklers to more and more residential buildings in the US.

So, while parts of the codes stay fixed for many years, others change rapidly, just as portfolio rules would.

Feb

22

 Here are the notes I use for teaching about electricity in an architecture college. They are simplifed explanations based on water flow analogy. Good for anyone wanting to understand electricity for any reason, including parallels to markets.

Volts measure the pressure difference that moves a stream of electrons through a wire.

Amps measure the number of electrons passing through a wire, also called current.

Watts measure the rate of work being done at a particular point in time.

All the above are directly analogous to waterflow. What location would you choose for installing a hydroelectric power plant? The Hudson River has many Liters of water flowing, but with very little pressure because the water falls only a few meters along its course. Forget it– The pipe draining rain from the roof of an apartment house has higher pressure than the Hudson River because the water falls many more meters, but it's no good either because it has only a few Liters of water flowing through it.

The Colorado River has both high flow and high pressure. Therefore it is a reasonable place to install a power plant if you don't care about fish or swimming. This is another way of saying that the Colorado River has a significant amount of energy to start with. If you want to actually measure the energy in the river to compare it to another river you need to know two things: the pressure and the volume of water available. If you multiply the pressure by the volume you get a number that can be used to compare the power in one river to the power in another.

Amps of electricity are like Liters of water: lots in the Hudson, but few in the roof drain.

Volts are like pressure: lots of pressure in the drain pipe but very little in the Hudson.

Watts is a measure of power in either a river or a wire. Power is the ability to get work done, like lifting a weight up a hill, or heating water, or lighting a light.

The high voltage electricity for a car's spark plugs gives you a nasty shock if you touch it because the high pressure (voltage) goes right through your skin, but there's not enough power there to keep a light bulb lit. The D cell in a flashlight puts out only 1.5 volts, which can't push through your skin, but it can light a bulb because it puts out enough power. So how is power measured? Power is measured in Watts. Just as Hydroelectric power is dependant on both pressure and volume, electric power depends on both Volts (pressure) and Amps (volume).

If you measure the number of amps flowing through a wire and measure the number of Volts pushing the electrons through the wire and multiply the two together you get the number of Watts. In other words a wire needs a significant number of both Amps and Volts to have usable power (Watts). The math makes it easy to figure out the Wattage, Amperage, or Voltage if the other two are known.
Amps x Volts = Watts Watts/Volts = Amps Watts/Amps = Volts

Which uses more power? (and puts out more heat)

An electric heater rated at 220 Volts and 10 Amps or a heater rated at 110V at 20A?

220V x 10A = 2,200W 110V x 20A = 2,200W Same in both cases!

What size fuse or circuit breaker can handle the amperage from a 3,000 Watt heater plugged into a 110 Volt outlet?

3,000/110 = 27.3 Amps is the amount of current passing through the wire, so use a 30A breaker.

How much money will it cost to operate a 24Volt transformer to power a thermostat for a year? The transformer is rated at 40Watts (also called 40VA, or Volt-Amps) and electricity in New York City costs about 14 cents for a Kilowatt-Hour:

A Kilowatt-Hour is 1,000 watts used for an hour, or any equivalent such as 100Watts for 10 hours, etc. The transformer runs for a year which is (24 hours x 365 days) 8,760 Hours x 40 Watts = 350,400 Watt-hours. Dividing by 1,000 to get Kilowatt-Hours gives 350 Kilowatt-Hours. Since electricity costs 14 cents for each Kilowatt-Hour: 350 x .14 = $49.00 worth of electricity for the year.

How much money will you save if you replace a B & G 100 with a Taco 007, when both pumps run 1/2 the hours of the year? The B & G 100 uses 201 Watts and the Taco 007 uses 81 Watts. 8,760/2 = 4,380 hours in 1/2 the year. 201 Watts minus 81 Watts = 120 Watts saved. 120Watts x 4,380Hrs = 525,600 WattHours saved which is about 526 Kilowatt Hours x .14 = $73.64 worth of electricity saved.

Watch out for decimal place errors when dealing with money - 14 Cents is the same as 0.14 Dollars.

Which heats water faster? A 5,000 Watt electric heater or a 40,000 BTU gas fired water heater?

3.4 BTUs = 1 Watt for one hour, and 3.4 BTUs per Hour = 1 Watt. An electric heater is considered 100% efficient while it's running, while a gas fired water heater loses about 20% of it's energy up the chimney while it's running.

The useful output of the gas fire is:

40,000 BTU (input) x .8 (80% efficiency) = 32,000 BTU (to water) The other 20% went up the chimney.

To convert to Watts:

32,000BTU/3.4 = 9,412 Watts. This is almost double the 5,000Watts of the electric heater. Therefore the gas water heater will heat water almost twice as fast.

Useful Facts: One KiloWattHour = 1,000 Watts for one Hour.

One Therm of gas = 100,000 BTU. One Gallon of #2 oil = 140,000 BTU.

The electricity grid in the US is about 31% efficient, so using one unit of electricity is the equivalent of using about three units of fossil fuel at a power plant.

Feb

21

a voltage dividerPassing an asymmetric jagged rock in the middle of a stream today, one was struck with the forces that determine the speed and amount of the water that passes by each fork. The theory of least effort means that the force of the water through each fork will be the same as in a parallel circuit where the voltage in each fork will be the same as opposed to a series circuit where all the water must pass through each point.

I started to think about how to best model this with markets. The flow of money starts by taking many markets together as a stream takes a twig down it until it meets an obstacle. The obstacle might be an announcement or a sponsor touting a position on the media. Then the theory of least effort comes in, and the speed stops as the different markets go their separate ways.

Perhaps a better model would be a circuit with two different voltage sources at opposite ends both starting at different rates and then hitting that asymmetric rock at some point chosen by the higher feeders in the web. It would be interesting to quantify some of these dividers in real life that seem to occur so frequently at the middle of the day. What are readers' thoughts on likely approaches or models?

Ken Drees writes:

In a series circuit the voltage flows through each area of resistance (R) and the resistance is added together to form a total resistance. In a parallel circuit, as described perfectly like a stream hitting a rock and then now flowing down two channels, each channel contains some resistance. Unlike in series R parallel = R1 * R2 / R1 + R2, so the more resistors, the lower the total resistance and more water or current will flow.

So with the stream analogy, in normal markets funds flow in and travel through under this resistance force. In the spring its water level is high and forceful–much market volume — the banks of the stream mark the high point where total funds hopefully are contained — this high volume pressure digs the bottom of the streambed out and over time the banks do or will contain the highest capacity. The 100 year flood will always cause the stream to overflow. Is this idea of maximum flow worth anything market related? Maybe dealing with some form of trading limits or curbs or closures or halts. But, as the funds flow normally and are diverted down one path or the other and into the circuit — think of a leaf floating through–one side generally has less resistance than the other — some leaves go the faster way and some get crowded out and move down the slower path. Total resistance describes the net effect, not the individual effect on one's own water molecule. It seems like a randomness applies to which molecule travels in which channel. Yet in total all can be measured as a force and how this total force is affected by the constraints of the system.

In thinking about each channel, after the diverting point, the stream bed may be dug out deeper in one channel so more initial volume will first go there, then the amount of rocks, debris and resistance in this channel is endured causing a slowing. This series like resistance force pushes back towards the divergence point back up stream and thus moves some of the water into the other channel-which is then endured like a series circuit in itself.

Maybe the crowded and popular trades actually cause their own diminishment in that they can only entice so many molecules into their channel, eventually pushing back on themselves causing other traders who want to get into that channel to be drawn down another less crowded copycat trade. If Apple is getting all the big early action, trades then start to migrate to the apple-like companies assuming the same great things will happen there too. So a water molecule / electrical current with an emotional urge to start with, and then once you are in you get moved along for some piece of time and distance until the circuit is exited. 

Rocky Humbert adds:

There are only smooth rocks in a stable riverbed. The sharp-edged rocks quickly get worn down, leaving behind only smooth, Zen and polished ones. One can find market analogies that fit one's temperament if one wants to flow with the current and not against it.

Rocky Humbert, quantitative analyst, speculator and master chef, blogs as OneHonestMan.

Pitt T. Maner comments:

Going against the flow also occurs in nature even when the odds don't look very good.

Juveniles of three species of stream-dwelling Hawaiian gobiid fishes are flushed to the ocean after hatching and must climb massive waterfalls (up to 10,000x body length) to return to adult habitats.

Henry Gifford replies:

There is a non-linear relationship between energy and speed of water in this sort of situation. A simplified explanation follows:

For an object such as a bicycle and rider moving through air, similar to the rock "moving" through the water, for a given size and shape (aerodynamic coefficient) the friction increases as the square of the speed, and the energy used increases as the cube (third power) of the speed. This assumes turbulent conditions in the air or water, which is the case in most practical situations such as the rock, a bicycle, normal water pipes, etc. No, no energy is made to disappear– it almost all ends up as heat in the fluid downstream, heating due to friction of turbulent mixing.

A better but simple explanation is available in Bicycling Science, by Witt and Wilson, MIT Press, first published in 1974, still on the shelves at B & N, very good book for understanding a nice mix of practical and theoretical. My father special ordering me a copy when I was 14 much influenced the way I think today.

Analogies between electricity and water flow are common, but with electricity things are much simplified by many resistances being fixed, while in the real world they are often variable. In water flow, practically sized pipes have turbulent flow in them, which means doubling flow increases resistance by four– squared relationship.

This means that solving flows in parallel piping networks requires solving simultaneous equations.

I invented a mathematical method for simplfying pipe flow problems to where they can be solved on the back of an envelope. Explanation downloadable here. Scroll down to "Energy Used by Pumps". Basically, one coefficient is substituted for a whole range of possible flow and friction values, which can be translated to pipe sizes and legnths, which perhaps has some use in markets.

Jim Wynne corrects:

As for "force", if you double the force you double the force. There is no "extra" multiplication factor. Newton's first law of motion says F=ma, or Force equals mass times acceleration. For a given mass, if you double the applied force, you double the acceleration. This is linear. There is no nonlinearity.

If one is referring to a rock lodged in a river bed, or stuck between other rocks, there are lots of factors besides the rock's mass that determine how much force is needed to dislodge the rock. A bigger rock presents a larger surface to the flowing water and will experience a larger force for the same flow rate. If you double the flow rate, to the first approximation your double the force. The nonlinearity comes in when you understand that with too little force, one cannot dislodge the rock. Once the force is large enough, the rock will be dislodged and move down the river until it becomes lodged in another collection of rocks or crevices. This process is very nonlinear. With the force being less than that "dislodging force", the rock stays in place. When the force exceeds the threshold for "dislodging", the rock will move and maybe travel quite a distance before it stops. It might even create an "avalanche" effect, which is a highly nonlinear event.

I don't see what you can learn from this example to apply to markets, which are anything but linear and very much moved by psychological "forces". You can try to use physics as a metaphor for the movement of markets, but I don't think that market behavior is ever linear like Newton's first law of motion.

Anton Johnson comments:

Financial markets and fluid dynamics share a chaotic nature. For example, the Venturi effect is a concept describing the velocity and pressure changes that occur as a fluid flows across a constriction. Engineers often exploit these pressure differentials to facilitate the movement of fluids, such as drawing fluids into the low pressure side of the constriction, without the need for a supplemental pump.There are numerous similarities between Venturi effect and certain market movements. Conspicuous are the connections between volume and price change magnitude before and after a news driven constriction. 

Pitt T. Maner III adds:

Geologists are always trying to figure out what the forces/environments were by the arrangement of sediments. Depositional environments and the spatial arrangement of sediment sizes are very important for determining the ideal places to drill for oil. It is interesting to note that the form most often seen is dendritic or tree-like in nature.

(Prigogine, 1997; Chaisson, 2001).

Global rules govern evolution toward increasing complexity in open systems:

1) Open systems attempt to return to equilibrium, a state in which gradients are minimized.

2) Open systems create dissipative structures to dissipate energy in an effort to minimize gradients.

3) Energy dissipation must be optimized.

4) Energy dissipation transforms energy from one form to another, generally from kinetic energy to heat. In the process of dissipation, entropy is created. Entropy must be transferred from the open system into the surrounding environment in order for the system to grow in complexity and continue to optimized. By optimally transferring entropy to the global environment the system can increase in complexity, the entropy of the global environment increases, and the Second Law is honored.

The dissipative structure must do two things: optimally dissipate energy and transfer the entropy created by dissipation to the surrounding environment. In the world, a single shape optimizes these constraints: the shape of a tree or leaf (Bejan, 2000). Tree structures are all around us: brains, circulatory systems, trees, root systems, clouds, heat sinks, deltas, channel drainage systems, and turbulence (Bejan, 2000) to name a few. All tree structures share common characteristics:

1) they have lowresistance pathways to optimally transport energy to dissipation sites.

2) Dissipation sites are located at the periphery of the structure because that is the optimal location to transfer entropy into the surrounding environment.

3) Low-resistance pathways branch so that the optimal area or volume is utilized for dissipation and the optimally maximum number of dissipation sites at the periphery of the system can be connected to the orifice or energy input site.

Many small dissipation sites are more optimal than a single, large site. We believe that these constraints are the global dynamics that govern the formation and evolution of most clastic sedimentary systems from bedforms to complex bodies such as submarine fans and deltas. It is for this reason that clastic sedimentary bodies have similar shapes: they organize into the shape of a tree or leaf at all scales, and in all environments of deposition, to optimally dissipate energy and transfer entropy.

Gary Rogan writes:

In a series circuit you add up the resistors. In a parallel circuit you add up the inverse of the resistors. What’s also interesting, that in a series circuit the total power dissipated is proportional to the total resistance for a given current, which is what all the resistors have in common. In a parallel circuit the power is proportional to the inverse of the total resistance for a given voltage (which is what the resistors have in common here). The trick in the market analogy is to identify the “force” equivalent to either voltage or current, or for that matter the multiple of the two, the total power, and figuring out how it distributes itself between the obstacles.

Jan

30

Greek Temple at AgrigentoGreek and Portuguese bonds are in a nasty spiral. Very little seems to be working in terms of convincing the markets to mop up some paper. Greece 3.7 2015 is now trading 86-86.5, yielding approx 6.6 pct and some long term Portugal bonds are down a point or so since yesterday. I don't think Europe is in any way capable of rescuing Greece, or anybody else for the matter; the virus will soon spread to Italy, as it suffers from the samle chronic high debt to gdp ratios as the afore mentioned countries. Thus the trade of the day could be long Bunds short Btps.

Jeff Rollert writes:

Would it be unreasonable to compare the inability of any country to act as the world's military police, and in a similar sense, one country being the worlds bank?

Seems like the ECB built a wing on their house with wood full of termites.

I've always enjoyed the science fiction writers observation that the world will never unite until there is a non-Earth threat. Perhaps that includes monetary unions.

Alston Mabry writes:

It used to be so simple: The Greeks would have a crisis, the drachma would fall, and the Neuro's would swarm down for sun and fun and economic stimulation. The Greeks then took the extra money and started another story on the house because they knew that keeping the cash was not a good long-term investment. You'd see half-finished buildings everywhere, bristling with rebar — just the local version of a savings account with a currency hedge.

Bruno Ombreux adds:

Have you been to Athens recently? That's exactly what they have. Half-finished houses. They don't even bother covering the concrete. I was told that it was for tax reasons. As long as the house is unfinished, there are no real-estate taxes. So they don't finish their houses. This is very creative.

Jim Sogi replies:

Same thing in Peru.

William Weaver comments:

I didn't attend either event, but I remember in 2003 when Athens hosted the FISA Junior World Rowing Championships and then in 2004 Olympic Games someone made a comment about how clean everything was. It wasn't until about a week into Jr Worlds that someone finally noticed the grass on the sides of the highway between the athlete village and the rowing venue wasn't grass, but a green tarp covering heaps of trash.

The state of the art rowing venue is to my knowledge abandoned today. It was also only finished one week prior to Jr Worlds, and no one thought to anticipate the mid-August winds that sweep the city. The winds created such waves that the Men's eights heats had to jump ship and swim their boats between 500m and 1000m to cross the finish. Finals were reduced from 2000m to 1000m. The Games were lucky and didn't have this problem.

But what about selecting cities in order to build athletic facilities that will help the community in years to come? I wonder if there is been any research regarding future price performance of munis issued to build venues for Olympic Games. Most venues go unused after the event.

Henry Gifford adds:

Another reason for the rebar sticking out the tops of buildings in some places is that they expect to build the building taller later, when money is available, but without a mechanism for collecting on debts there is little money available for lending, thus things tend to be paid for in cash, and built gradually. Here, with loans available, that strategy doesn't pay as well as borrowing the money to build a property to it's "best" economic use, as the cash flow is much worse on a partially built-on property - same land taxes, same land cost, lower return, higher hassle/permit costs for repeated small construction jobs.

Jan

5

Counted 58 jets over Christmas/New Year Week. Empty spaces. More small jets. This is thinner than prior years. It's still impressive to see a billion of hard assets parked there all shiny. The corporate guys probably can't use the company jets to fly their kids anymore. Some great custom paint jobs on the private jets.

Great waves over the week. The seasonals on waves are remarkably consistent with large global forces at play. No reason why markets should be any different.

There is really no such thing as randomness, only ignorance of real causes. The ancients attributed it to dieties.

William Weaver comments:

Kamstra, Kramer and Levi find in their 2003 paper "Winter Blues: A SAD Stock Market Cycle" that stock returns are significantly related to season. Their study examined equity performance during the six months between fall equinox (SEP 21) and spring equinox (MAR 21) for the northern hemisphere and the opposite for the southern hemisphere. Overall, stock markets underperformed in the seasonal summer and outperformed in the winter. As an example, the authors cite the returns of a portfolio invested 50% Sydney, Australia and 50% Stockholm, Sweden. From 1982 to 2001 the portfolio earned 13.1% annually. If the portfolio was rotated following darkness (SEP-MAR = Stockholm; MAR-SEP = Sydney) the portfolio returned 21.1% annually. Following the light (opposite above) the portfolio returned 5.2% annually. — Paraphrased from Inside the Investors Brain, Peterson

I ran the numbers through present and found significance using a sample of two means. The recent returns are less impressive; L/S is possible to create long term AR.

Also, are we able to understand all confounding variables given our position within the system? I'm going to open a bucket shop on the moon. No inter-sphere communication, just observation. The shop will be open to moon people with no connection to Earth.

Phil McDonnell replies:

Unless I totally misunderstand the point of the paper it shows that the strongest return in the US comes in Jan following a sharp rise from Oct through Dec. The weakest monthly return is Sep, which neither corresponds to maximum sun nor minimum sun. Apparently the claimed effect is that minimum sun causes us to buy stocks. This is not what I would expect if SAD is the true cause.

Also the claimed effect of a ten parameter regression explains only 1.1% of the variance in both US and Sweden. That does not give one much of an edge for ten parameters.

Henry Gifford writes:

Persons who have attributed aspects of human behavior to DNA/evolutionary related causes have noted that after 9 months in a relationship women ask for a longer term commitment, and then either receive it or move on.

William Weaver writes:

In the past four years I've ended four relationships in October or early November and started a new one in December or early January with the exception of one year where I started a relationship in June. Might this be influenced by weather/seasons or other variables that could influence behavior and thus financial market volatility?

Sep

28

Libertarians (other than me) are mostly united around the idea that global warming is not a problem, which I find a strange reaction, no matter how repulsive government involvement is.

Libertarians often say government health care is a bad idea, but don't claim that people don't get sick. Libertarians don't like government schools, but don't claim everyone can get a great education on their own. They (and I) say these areas have real problems, either caused by or not helped by government involvement. What of climate? Cruise ships will transit the Northwest passage in a few years, the first time the ice will be melted fully across in a very long time. So why when the planet is warming up and the government gets involved is a warmer planet not a problem?

Last week I listened to a PhD defense at the Goddard Institute for Space Study, the place where Jim Hansen and crowd have made some accurate predictions about climate change, predictions of the sort where they predicted future things before anyone had the data. I was struck by two things:

1. They were already modeling earth's poles with no ice as an everyday modeling activity, and then studying clouds and whatever else was the topic being studied.

2. The speaker tossing around a term like they used it all the time: 2xCO2. It dawned on me they were talking about CO2 doubling in the atmosphere, which is not far off if current trends continue.

It was back in the mid 1800s when CO2 was identified as a greenhouse gas. The debate was held in The Royal Society, and largely ended there as to whether CO2 is a greenhouse gas or not (See Note below).

I don't have faith that the models are trustworthy, but the data from countries that have less climate diversity than the US say things are warming up rapidly. US television stations are in many different climate zones, but all the TV stations in Australia are in places that are hot and getting hotter. Ditto for most of Israel. Some parts of the world are getting too dry for farming for the first time in centuries, even with pumped water. If this trend continues, much money will change hands because of it.

What investments would do well if the planet keeps warming up?

Approximately 100% of energy saving activities related to buildings in the US (and some other places) involve government programs, which are another story. Most efforts to make money on owning the infrastructure for supplying water end with protests about prices, and government seizure of the "privatized" water system. General Electric is heavily involved in manufacturing the equipment for water related products (large scale), and energy generation products as well, and they seem to be doing a good enough job to displace the need for many startups in these areas.

I think this will be an area of huge opportunity, but don't yet see what position to take.

Technical Note. The earth gains heat one way: infrared radiation from the sun. Our atmosphere, including CO2, is largely transparent to infrared radiation on the wavelength the sun emits: short wave.

The earth loses heat one way: infrared radiation radiated out from the earth into outer space. The CO2 and other gases (including water vapor) in our atmosphere are not as transparent to infrared on the longer wavelength the earth emits (because the earth's temperature is different than the sun's temperature), thus some of the infrared emitted is absorbed and/or reflected back. The more CO2, the stronger this effect, and the warmer the planet.

People argue about how much CO2 will have what effect, but nobody disputes the operation of the basic mechanism.

On another subject: There is no evidence yet of green-collar work on buildings saving any energy.  See an article in the NY Post in which I am quoted:

LEED buildings don't conserve energy. In fact, a LEED study commissioned by the USGBC suggests that certified buildings often use more energy.

Much credit for this discovery goes to a Manhattan building-energy consultant, Henry Gifford, who was the first to blow the whistle on the USGBC's bogus promises of energy savings.

William Brauer writes:

As a Libertarian and noting that Greenland was once green, I'm not sold on manmade CO2's being the big driver in warming and find recent literature on sunspot activity to be compelling. I don't agree at all that Libertarian beliefs dismiss public education, though the belief would be that a private enterprise would out perform a government-run school (read Harvard v. UMass). As a Libertarian I do not deny that people get sick, but if we must take a program approach to increasing access to care, we would increase incomes to enable the poor to afford insurance rather than wipe the slate clean and start a government managed system.

Jun

11

V NSometimes masters can be recognized by how little motion they make in beating you or relieving you of your funds. On this score, note the S&P in a three point range on five consecutive days, and eight of last 10 closing prices have been between 839 and 843. I find that the old mistress has not done this once in the last 15 years with the closest virtuous performance being on October 11, 2006 with the ranges widened to three. Hats off. What does it all mean? What's the sports analogy?

Paolo Pezzutti answers:

I see two boxers studying each other during the first rounds of a fight to find out weaknesses and strengths of their opponent. They test and experiment, trying some punches and techniques, moving around the ring to gauge capacity and time of reaction. They get ready and prepare the assault. When the moment comes, the fight develops furiously and fast with opponents using all their ammunition to try to knock the other out. When this type of match occurs, it is hard to figure out during the first phases who is going to be the winner. Deception to cover one's own weaknesses and strengths makes it quite impossible to bet on the outcome, unless you know values at play. Today's afternoon move could be one of these deceptive moves to be faded.

Thomas Miller adds:

In a most martial arts matches, the superior fighter expends as little energy as possible while letting his opponent expend his energy, become frustrated, lose concentration, and eventually lose the match. A wise fighter who is outclassed and knows it avoids the fight to begin with, waiting for a another day and a better opportunity. A wise trader would do well to avoid tight range markets waiting for another day and better opportunity.

There is tension in this market like a spring winding tighter, waiting to be released.

Henry Gifford comments:

A tiring bicycle rider can be seen many ways, with the most obvious being movement of the shoulders as if there were a second set of pedals connected up there, which of course is not the case, meaning all that movement is wasted.

Mar

23

 Given the current mortgage rates and the fall of the housing market, I want to purchase my first home. Since I am stationed at Fort Hood in Texas, I have been doing heavy research in the Killeen / Harker Heights area. I thought I would ask for some advice. I spoke with Tim Melvin about this earlier, and he mentioned that I should never pay more than 10 times the annual rental rate of comparable houses. Does anyone else have any other good valuation metrics like this or have any knowledge / advice that would help me out as a first time homebuyer?

Legacy Daily replies:

I have found 10x to be used in two cases:

1. High house prices relative to rent — get one to cool off and think more clearly about an investment and do additional homework 2. Low house prices relative to rent - get one to jump in without thinking clearly on a "bargain" investment without doing any additional homework 

Some initial questions worth clarifying:

1. Is this a home or a leveraged investment? a. home — ignore rules like this and find the best place to live, raise a family, pursue happiness… b. leveraged investment — do enough homework to be confident enough about the decision to ignore all general rules.

Assuming investment:

2. What is the holding horizon? What future plans could interfere with that holding horizon? 3. What is the appreciation potential for the country, state, county, city, town, neighborhood, subdivision, this property…? I have not yet been able to come up with sufficient justification to buy for income alone when it comes to residential real estate. 4. What segment of rental market would the property (subdivision, neighborhood, town, etc.) attract? Is that the segment one wants to serve? Real estate agent needed to rent? 5. How predictable is the income stream? How would economic booms/busts affect it?
6. What are the worst case scenarios? What could go wrong?
7. Financial analysis — P&L, tax impact, financing options, downpayment flexibility (very illiquid), initial estimated repairs, etc. 8. Legal analysis — zoning issues, easements, property title issues, locality department issues, neighbor issues, etc. etc.

Couple additional points:

1. Decent real estate attorney representing one's interests can save from numerous headaches (especially true in foreclosure/short sale cases). 2. Avoiding a buyer's broker saves one money, gives additional negotiating room, makes the seller's broker more willing to work extra hard for the deal. 3. Inspections are money well spent, even if one does not end up buying the property. 4. The market is generally very efficient (yes even during this recession). Why has the property one's considering not sold yet? etc.

I hope you find this useful.

Jim Rogers writes:

The rule of thumb I've heard used is 1% of sales price should be equal to or less than comparable monthly rent (that's a little more aggressive than Tim Melvin's measure, especially when you factor in the mortgage tax shield). I'd say, use either and stick to your guns.

Sam Marx replies:

Don't trust what the real estate broker says about a house's value or price. Do your own research.

Try to find prices of recent sales of similar houses in same neighborhood.

Check with the local banks to see what houses they now own and what are their asking prices.

If you can go to foreclosure sales, do it, not to buy a house but to get an idea of what the market in houses is and remember those prices when negotiating with a broker.

I don't recommend buying at a foreclosure unless you're experienced at it.

Don't be shy about making offers 25-30% below asking price when dealing with a broker.

Watch for estate sales, the heirs are motivated sellers.

I don't know your area, maybe it's reached a bottom, but in FL, housing prices are still too high. The stock of St. Joe Land (JOE), FL's largest landowner, was 69 a few years ago — now it's 15.

Phil McDonnell advises:

 Buying a first home can be a frightening prospect. It should start with a realistic look at your needs. How many bedrooms and baths do you need now and in the future? If your life involves one or more women strongly consider the extra bath. If you have the skills a fixer upper my be of interest.

I frequently advise my Realtor wife on the statistical aspects of our local real estate market. Pricing in this market is especially tricky. It is a declining market but that also means buyers have much more negotiating leverage. To measure your local market ask a local Realtor for the latest stats on number of homes on the market and number of sales in the last few months in your area of interest. For a normal market this is about a four month supply of homes at the current monthly sales rate. In this market it is running about 10 months of inventory per home sold. Hence the declining prices as sellers compete. One should consider staying out of the market until the inventory show signs of declining. However do not be fooled by a one month decline in local inventory. Buyers in the Seattle area are negotiating prices an average of 4% below asking. Get the similar number in your area.

As a buyer in this market it is best to view the prices as a price distribution. Suppose we have ten houses in your area. But only 1 will sell in the area in the next month. Clearly it is most likely to be the one that offers the best value on a relative basis. The other nine are over priced for these market conditions. By staying on the market for another month they will probably lose something like 1% in value per month.

There is an old saying in real estate. One should buy the least expensive house in the neighborhood. Generally this is true. After numerous regressions on homes it can be said that among comparables the most important single factor is square foot of the house. For the best resale find out which area has the best schools. Even if you do not have kids the people who ultimately buy your home may have them and it will help resale in the long run.

Check out all the government mortgage deals and tax subsidies. They are offering a tax credit of up to $8,000 for first time buyers. 30 year fixed rates are below 5%. The military may offer even better deals. Remember the $8,000 credit is only paid the following year via a refund so you do not have it to use as a down payment. It is more beneficial the smaller the house you buy. I saw a recent home sold for something like $80,000 in Killeen. The $8k represents 10% on that home, but only 5% on a $160k home.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Henry Gifford adds:

Home prices, in general, are still falling in the US, therefore waiting will probably bring lower prices.

As property prices fluctuate, one sign of high prices is easy loans. Times when prices are better tend to be times when loans are hard to get, with of course reasons for this relationship. But, as an affiliate of the military, there are sometimes special deals available to you that are not available to other people, which means you can be one of the few buyers out there at a good time to buy. Some of these loan deals only exist on paper now, as the price limits and interest rates make them impractical, therefore nobody talks about them, but because they are government programs which get updated slowly, and usually out of sync with the market, they can be really good deals at times. Therefore there may come a time when you can get both a good price and a good loan.

Buying near a military base involves risk of base closure (I owned a whole bunch of houses near a base that closed) or downsizing, and since you're in Texas where there is lots of land, upsizing the base won't put much pressure on prices - people will simply build more houses. Perhaps you can ask around inside the gates to get a feel for this.

Buying and selling property involves large costs for brokers, taxes, title insurance, etc., which penalize short term ownership, meanwhile you can get transferred to another base at a moment's notice, which puts you in the position of being in a hurry to sell. If, instead, you buy a commercial property, you can own it as long as you live, with far less management headache, which makes owning it while living elsewhere more realistic than renting a house to someone.

Phil McDonnell responds:

I think the truth in this statement is based on a defect in the way people perceive value. Suppose the average home in a neighborhood sells for $500k but yours is worth $400k. Then if the average goes up to $600k the innumerate masses will think that all homes have gone up $100k not the 20% they really should have. When they do this the $400k home appreciates by 25% not 20%. In other words people add when they should multiply by a percent increase factor.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

David Hillman writes:

Another part of that defect is focusing on the value of the improvements v. the value of the land.

Some years back, a close friend bought a lousy house on a great piece of property in the best neighborhood. Even though it was a prestigious address in a 'branded' area, he got a deal on the property because the house was so undesirable. The plan all along was to demo the house and built a new one to suit, which is exactly what he did. He had realized the land was worth perhaps 90% of the true total value of the property before the new construction.

Many county auditors, etc. have searchable tax records online with the assessed values of land/ improvements parsed out. One might use that to figure a reasonable estimate of market value of land v. improvements. Don't forget the old saws apply….'land, they're not making any more of it'….and….'location, location, location.'

Bill Egan writes:

In the last 10 years, I have bought three homes and sold two. Did not plan to, but that's the way it worked out due to job changes. Sold both houses in < 1 week for a profit despite forced timing. We were not in subprimeville, either, and the last sale was 2001 before the real estate madness.

My wife and I kept resale value in mind because you never know what can happen to you. We made sure we bought homes that were average to excellent on the following criteria:

  1. School quality
  2. Exterior appearance and interior layout — good and normal
  3. Quiet, safe neighborhood that looks good
  4. Reasonable size (3/2 or larger)
  5. Likely demand due to commuting routes/distance to jobs

For example, I was working at a biotech in NJ from 1999-2001. We bought a 3/2.5 in a newer development, nice neighborhood in Burlington County, right next to an average-quality elementary school. However, the area was less horridly expensive than the homes closer to Princeton, where I commuted to. There was strong demand from people priced out of the homes closer to NYC/Princeton.

Rich Bubb replies:

1.  look at the neighbors. C-L-O-S-E-L-Y… look at the state of their domiciles (even getting "invited-in" for a look see if at all possible), and the state of the upkeeping… especially the immediate next door folk. You might end up living next door to your own personal nightmare. Believe me, it is Not Enjoyable. Even after almost 20 years. Thankfully everyone else on the entire block is somewhat more sane and respectful of their neighbors than my nextdoor nightmare. Or to put it another way: you might get the best deal that no one else could stand…

2. if you really know somebody in the real estate biz (my sister is an agent), have them look around for you. she got her daughter's family a fabulous deal in a great neighborhood. Or to put it another way: sometimes real professionals Do Know what they're doing.

3. look long at the deal, bid low for the deal (Game Theory might help a little here, here is a cool intro), then be prepared to walk away… even if not doing the deal means you'll have to go back and start the whole search-etc process all over again, and don't put pressure on yourself or let anyone pressure you into buying. My wife was not prepared to walk away from her last car purchase. She still got a good vehicle, but she could've strengthened her bargaining position by uttering the words, "Let me think about it." And then purposefully heading for the door. We went outside and argued between ourselves about leaving. She *wanted the vehicle*. It cost her almost $5k more than I wanted her to pay.

4. Consider the cost of long term ownership. I mean, Really figure it out… what's the cost of x, and y, and z, and can you afford it if those costs all hit at once.

5. Tangentially to #1 above, if there'll be kids living next door… would you:

(a) invite them in?, or

(b) chase them away?, or

(c) start scouting for really out-of-the-way burial sites?, or

(d) let them borrow your most deadly power tools?

Just mentioning this as my siblings and I were the 'b-c-d' and almost always the Never-more-than-once 'a'. And the neighborhood's less-than-model parents would often let their barbarians-in-training train at our place… Or to put it another way: your neighbors' kids might have fiends, er friends, worse than they already are…

Hmmm, karma might really exist…

Russ Herrold adds:

A anonymous blogger, 'Benjamin.Publicus' on Thomas Paine's blog  had this this observation:

… The author lives in a community that is (or was) at the epicenter of the mortgage crisis. The developer aggressively marketed the homes to young, first time home buyers, many of whom renters. No money down, own instead of rent, mortgage payments the same as the rent, etc, etc. The development was started in 2001, so the first wave of 5 year ARM's hit in 2006.

…and it goes on from there.

I have spoken to that author (and a couple others) about contributing to DailySpec, but he has been busy.

Dr. Herrold is Principal of Owl River Company, a high-end Unix consultancy

Rich Bubb adds:

As mentioned previously, my sister is a real estate agent. following are her comments on home shopping & buying.

Get a Real Estate Agent to represent YOU as a BUYER. Sign a contract as such. Tell them what YOU want.

There are surely things important to you that you would like to have in one of the biggest investment decisions you will make.

TAKE NOTES of likes/dis-likes of each home you view. re: Basement, Garage, Four Bedroom, Square Footage, LOCATION. I stress location because it can make or break the satifaction of your purchase.

Drive through the neighborhoods you are considering at different times of the day to see what the atmosphere is.Pay attention to the neighbors up keeping of their property. Schools?, established neighborhood?, new additions? child / adult ratio?
Comparison shop, don't just jump at the first home you look at just because you can afford it. Ask your agent to provide you with a CMA (a market analisis of a surrounding area - 5 mile radius ).

Get pre-approval from your lender, look at homes a bit higher than your range and offer LESS - the worst that can happen is, they will say NO or counter-offer and you may wind up with a nicer quality home.

BE Strong in making the decisions of your offers. Be prepared to give and take.

Then BE PATIENT thru the purchase process which seems like it takes forever because we are a see it, buy it, want it now, kind of people. It is a process that is in place to protect you. re: CLEAR TITLE

Again, don't just settle for a home, get as close to what you want as possible.

Dec

1

 Back when I was a freshman in college, I had to take a course in University Physics. I found the course to be most practical, and helpful in the development of my thinking. One phenomenon that we studied in that class was the concept of Parallax. A quick Wiki definition of parallax is:

"Parallax is an apparent displacement or difference of orientation of an object viewed along two different lines of sight, and is measured by the angle or semi-angle of inclination between those two lines. The term is derived from the Greek parallaxis, meaning 'alteration.'"

A person can observe in real life the effect of the parallax by measuring something, using a ruler and not looking directly over the scale. By looking at an angle other than directly over the scale will cause a measurement error due to the parallax. That error can be measured and corrected by knowing the distance from the object and the angle. One's measure of the market might be affected by an internal, mental parallax. This parallax might be a function of the time frame, or might be something else… what else I don't know. It would be interesting to see if anyone has studied or quantified this concept as related to markets.

George Zachar adds:

 Greybeard camera buffs have studied this, using twin-lens reflex (TLR) cameras. One of my prize possessions is the Voigtlander TLR my dad took with him, fleeing Europe in 1949.

Lots of info on this phenomenon in photographyland.

Don Chu writes:

 “The stars are the apexes of what wonderful triangles! What distant and different beings in the various mansions of the universe are contemplating the same one at the same moment!” (H.D. Thoureau)

Thoreau probably did not have in mind stellar parallax in relation towards distance computation, and his imagined use of triangulation is more a heartfelt outreach to find resonance with another, be it of this world or otherwise. Still, there may be something in Thoreau’s words that transcends their initial appearance and speaks more directly to Mr Watson’s musings.

Thoreau continues from the above: “Nature and human life are as various as our several constitutions. Who shall say what prospect life offers to another? Could a greater miracle take place than for us to look through each other’s eyes for an instant? We should live in all the ages of the world in an hour; ay, in all the worlds of the ages. History, Poetry, Mythology! — I know of no reading of another’s experience so startling and informing as this would be.”

Paraphrasing and taking enormous license with the inimitable Thoreau and one contemporary other, perhaps the inspiring lines above may be reduced to the more familiar and definitely modern - “a latticework of mental models.”

Mr Watson rightly postulated “internal, mental” parallaxes predicated upon by any number of possible variables. But one fears that trying to elucidate error terms in any single mental construct may necessitate recourse to never-ending phenomenological reduction and render any resulting “cognition” and perceived derivative error to be indeed, in doubt.

The unkindest and yet most impersonal a priori parallax may come from the observer himself, delivered through the remorselessly agnostic Observer Effect. In the context of the markets, presupposing that the state of a market system exists independently of its observer/participant will surely be unwise and inevitably, loss-making.

But here is a naive yet hopeful thought — perhaps singular errors from any one mental construct matters less from the perspective of the whole. If every man holds in his mind (and inherently all men do, to a greater or lesser degree), a “latticework of mental models”, then in a mind where the structural tensions and forces remain basically stable, it follows that individual mental disjoints/errors have mitigated and largely damped themselves out.

Perhaps a healthy dose of History, Poetry, Mythology! shall prove to be rather profitable…

Henry Gifford comments:

Older meters of the type used to measure electronic circuits have a speedometer type needle that moves across a numerical scale. To eliminate parallax there was a mirror mounted just above or below the numbers scale, which allowed a user who was not viewing the instrument from directly ahead to look at both the needle and its reflection, and use the reading that appeared midway between the two.

It reminds me of looking at currency values relative to other things instead of just each other.

Perhaps some prices of seemingly unrelated markets which have predictive value that could be used to trade in one or both of the seemingly unrelated markets.

Nov

12

 Right now we can all maybe take a lesson from Donald Trump's father Fred. During the depression, his father (who was a builder) told his subcontractors they can work for x dollars to build a building. They did the math and said, "we can barely survive on those prices - we won't make any profit at all!" He said "yes, that's true, but when the slowdown is over, you'll be the owner of a construction company". As Fred was well known as a man of his word, who paid his bills on time, you can figure out the rest of the story.

In the 1980s, when the NYC government had been trying for years to build a skating rink in Central Park, and failed again, and responded by appointing a comission to study the matter, Donald Trump told the newspapers he would build it for what they had budgeted, and have it ready by the winter, and pay any cost overruns out of pocket. In other words, he was sparring with the mayor on the front page of the tabloids in a city where his business depended on "favors" from the government (permits, etc.).

The mayor could hardly say no, so Trump told Anthony Gildeman, a recently hired employee who had been comissioner of housing in NYC (never mind), to go find out who is the best skating rink contractor around and "fly him in here." They listened to the guy (from Canada) explain what the city was doing wrong, and to his idea about how to get it done well and quickly. Trump almost gave Gildeman a heart attack by saying "Hire the guy," this without a year of requests for proposals, inquiries about contracts going to people who have donated to the right funds, etc.

The rink was done right, on time and I think under budget. The only glitch was the parks department planting a tree on opening day, which involved driving a large truck on a grassy hill after a few days of rain….

I think the story is mostly or all true the way I heard it, and if people are taken in by his image, and will pay extra for a condo with his name on it, or pay $3,000 for a handbag, I just love the USA.

Sep

22

I got an email from a friend that I don't agree with, but I could use some help responding to it. How would you respond?

In the context of our ongoing discussion of markets and government, I can't help but feel that the meltdown of the last week lends considerable weight to my position that in the face of the value-neutral tendencies of free market capitalism the participation of a well informed, active public sector is imperative. There is a flip side to the way markets liberate economic energies; markets can become self-devouring. I accuse libert@rian ideas; they have brought us in large measure to this pass, because they foster a basic contempt for governance, ("government is the problem") the hallmark of the Bush administration.

When Robert Rubin bailed out the Mexican government by offering 20 billion dollars backing for their currency, there were howls of protest and forecasts of disaster from conservative minded politicians. Bush's laissez-faire attitude has resulted in a truly incredible 1 trillion dollar (!) giveaway. A replay, but only worse, of the S&L debacle that followed in the wake of the great free marketeer Ronald Reagan.

My friends B*b & I**a have three kids. B*b lost his teaching job.

Thank goodness that Connecticut has a "socialist" health program for people earning less than a certain amount. In Mississippi no one would come to rescue them. It would be against the grand american principles of self-reliance (or rather no bail outs for the powerless).

I'm not saying that I disagree with Paulsen and Bernake. At this point they have no choice but to intervene. But to my way of thinking the mistaken belief that the government should stay out of the way, the markets will take care of everything if left to their own devices, has led to this desperate state of affairs. Ironically, it is about is about to result in the greatest growth in government power since FDR.

My concern is that unlike the New Deal that sought to put people to work and create an ethos that we are all in this thing together, the current program will be directed at easing the pain of those who reaped the most benefits in the good times.

Henry Gifford responds:

FDRIf the mortgage market was really a "free" market, and not regulated, anyone putting money in would know there is risk, and not look to be bailed out. With regulation comes the excuse that the system let someone down, thus the system should come to the rescue.

And, if the mortgage market was really a "free" market in the sense of not being backed by Freddie Mac, etc., the penalty of default would be on the lender only, who would have watched out for their own money, and stopped making loans long before the appearance of billboards advertising 110% loans.

If the mortgage market was really a "free" market, Consumer Reports, Ralph Nader, etc. would be competing to sell information on which banks are safest, including selling stickers banks could put on the front window. The level of corruption in these private rating systems would be kept low for the same reason Coca-Cola doesn't cut corners by selling dirty or diluted soda, and the only cost to the citizen/taxpayer would be paying Consumer Reports, etc., if they chose to do so to get information to improve their decisions.

Craig Bowles writes:

Murray Rothbard’s History of Economic Thought is on six tapes but I don’t think he ever wrote the planned book. He didn’t think too much of Thomas Sowell. The tapes talk about Austrian economic theory which is the basis for libertarian views. He says that intervention alters the business cycle and causes inflation during the slowdown. The worst part though is it disrupts the allocation for production, so you get overinvestment in some areas (houses) and underinvestment in others (oil) with the liquidity-driven inflationary booms. Really great tapes and very applicable to today.

Jul

9

T. Boone Pickens is promoting wind and solar power on his web site and in ads.  Is he trying to become a politician? Not likely, he is a consummate businessman.  (A reader).

 Solar electric plant in the US currently costs $9 per noon Watt (Sharpusa.com), and in the US each Watt of noon capacity that is installed in an ideal way, (proper angle, proper azimuth, never shaded) yields about 1,000 Watt-hours of electricity per year (American Society of Heating and Refrigeration Engineers Journal) after conversion to AC. The average US price for 1,000 Watt-Hours of electricity, which the utilities call a KiloWatt-Hour, is just under 9 cents (US Energy Information Administration Website).

Divide $9 by 9 cents to get the "simple payback" in years, not including maintenance, equipment replacement, changes in the price and value of money, etc. for investing in solar electric generation.

Wind in the US is Federally subsidized at $80 per MegaWatt-Hour, which is a less straightforward way of saying 8 cents per KiloWatt-Hour - almost the full retail price of the electricity. However, depending on the location, the unsubsidized economics are reportedly attractive in some cases.

Businessman or politician? I don't know. I think it depends on what he might actually know about the economics of solar and wind, which is hard to figure out at a distance.

Jun

19

There seems to be something odd going on with German real estate. People are clamoring for 'energy efficient' apartment/office blocks that are near the city centre, whereas many older buildings in the outskirts have a low rate of occupancy. (From a British friend visiting Germany).

The clamor for "green" property in Germany is driven by social pressures, not economic pressures, even though they have been much, much better at energy efficiency than the rest of the Western world for decades.

Immediately after WW2 the Germans started doing serious, formal research into how to make existing or new buildings energy efficient, while most of the rest of the world was mostly not thinking much about it. About 15 years ago some of them realized that a graph of the increased construction cost to make a building more energy efficient vs. the payback is not a straight line - it has many bumps in it. One major bump occurs where the building is energy efficient enough to not need a heating system. Spending slightly less on efficiency means buying a boiler, heaters, piping, etc, and spending slightly more means greatly diminished return on investment. Ironically, in researching these ideas they came primarily to the US, where we've built 2 or 3 such houses per decade for years. The Germans wrote a standard for how to do this, and as of 10 years ago they had built 6 such buildings, all single family residences. Now they have well over 10,000 built new and renovated, not only houses but sports facilities, office buildings, schools, apartment buildings, etc., often for lower cost than normal buildings, because of the decrease in construction cost associated with skipping the heating system.

Perhaps their culture has something to do with it, and with our attitude too, as our parents' generation came to literally rule the world by controlling access to oil in WW2 (the fighting in Burma was not about palm trees, ditto for Romania, the SouthWestern USSR soviet oil fields, etc.) The Japanese sent the world's largest battleships out to fight without enough fuel for a return trip, and when the Germans made the world's first jet fighter planes they were rumored to be towing them to the runway with horses to save fuel, but that was not true. The army had all the horses, the air force used cows. Now Germany and Japan are the most energy efficient countries in their hemispheres, while Russia and China and the US, who won the war, are the least fuel efficient.

In the US we've been responding by clamoring for "green" buildings which in fact use more energy than comprable buildings (on average), but with almost nobody asking to see utility bills and almost nobody showing bills, worse and worse buildings become more and more popular. Ditto in Germany, as the image of environmental friendliness sells much better than actual environmental friendliness in the form of energy efficiency or any other form.

Certainly an example of the lack of counting having a huge effect, and the public paying more than they deserve to pay to end up with something that has less real value than simply buying nothing.

Apr

5

For SaleA person buying property for investment is doing three things simultaneously, even if he doesn't admit it:

1/ Running a real estate business, including headaches, deadbeat tenants, vacancy between tenants, etc., for which costs and lost rent should be included in an analysis, as these are not minor costs.

2/ Speculating on the value of property going up or down.

3/ Speculating on the value of the dollars borrowed for purchase going up or down.

The third one is often overlooked. Picture buying an apartment for $100K cash (in real estate terms, that means writing a check for $100K, no loan involved). Then picture that with inflation, after X years the value of the dollar went to 1/2 with no change in the value of the property. Selling it would yield $200K, which after taxes on the $100K "profit" would yield a loss of $50K in future dollars, or $25K in present dollars.

As an alternative, picture buying with 10% down and 90% borrowed. After X years the proceeds of the $200K sale go $90K to the bank (assume no amortization, for simplification), $20K to pay back the $10K down payment, $50K to taxes, which leaves $40K profit (in future dollars).

The interest on the loan makes things more complicated, of course. It means likely not paying taxes on other, similar deals that made a profit at the same time, so the above deal maybe should show a profit of $90K in future dollars. It also means that instead of choosing between paying $100K "cash" or $10K down and investing $90K, another option is buying 10 apartments for $10K down each.

Of course the interest payments are a cost, which need to be looked at. One good way to do this is to compare the interest rate to the "cap rate" for the property. The cap rate is the annual income divided by the property price, which is just the income from the property. It is, or should be, figured including all costs, including tenant hassles, but not include any interest costs. If the property is making 8% and the money costs 6%, that is a good sign, and will make the return on the 10% down payment really high. If the cap rate is 4% and the money costs 6%, the deal will lose money steadily, but perhaps be bailed out by a sale at an increased price. This is exactly what most deals look like, especially in recent years: they lose money steadily until sale to someone else who does the same thing and hopes not to be the owner when prices drop. This time around it may be a little different, as the loss to the "last" owner is increasingly spread among all taxpayers, but that's another story.

As much of the price increases lately have been due to inflation (narrowly defined by me as a drop in the value of money), and only some is due to an increase in the value of the property, buying with a loan is also a gain from shorting the dollar: profits are made from that "option" trade if the inflation rate is higher than the interest rate, which in effect makes the interest on the loan a negative number. This has made many people rich, who either aren't aware of this or won't admit it, preferring to think they made the money from choosing better paint colors.

As prices are dropping now, it strikes me as sensible to wait at least one or two years before buying. When cap rates are higher than interest rates, that's the time to buy, as everyone will be saying "I got burned, don't bother with buying property".

Mar

3

LG wrote:

What is wrong with my logic here?

Over the course of time, accurate brick laying and other construction tasks will become automated using numerical control processes pioneered in the aviation industry.

This will bring down the labor costs of building as well as reducing construction time..

Therefore the price of property is likely to reduce

Based on my experiences in the machine shop my father had in the basement, on my building of machinery to automate factories, and my experience building buildings, I think little will be automated in the construction industry.

Many have tried, with prefab bathrooms, prepackaged piping sets for kitchens and baths, and other things that make sense but don't catch on. Today in the US some 5% to 15% of new houses are factory built (depending on where you draw the line between "house" and "trailer"), but even they are not very automated - they benefit from protection from weather, stockpiling of materials, easier quality control, etc., but not from automation.

The main difficulty in automating construction tasks is setting the machine up for the many different sites, methods, dimensions, etc. Everything is already set up to be done by unskilled or semi-skilled labor.

Interestingly, after each building boom ends, the materials, codes, technologies, and economics change enough for the whole industry to have to reinvent itself for the next boom. During the last boom (just ending) insurance became major, and the ability to get a bond became a major cost of entry, effectively barring new entrants to the industry for the last few years. Labor got relatively cheap as material prices boomed, but that ratio has shifted back and forth many times in the past, as it will presumably do again in the future as Bacon's principles describe.

As for automation having a significant effect, it hasn't started yet, and I see no signs of it yet, but who knows.

Feb

11

Luck, from Jeff Watson

February 11, 2008 | 6 Comments

CubeAll my life, I've heard the familiar refrain on how "So and so is such a lucky person, they always win." I've been to the track and seen guys sweep the whole card of trifectas, much to the chagrin of the losers who attribute this feat to that elusive concept called luck. I've seen people throw away all of their money in pursuit of the long shot, afterwards labeling themselves as "Having a streak of bad luck." The concept of luck always intrigued me, and caused me many sleepless nights in grad school trying to prove, or disprove luck's existence. After a few months of thought, I eventually came up with a very elegant proof that denied the existence of luck. Ever since that moment, equipped with a new mind set, I have viewed all events as random occurrences that are subject to the laws of probability. This idea served me very well over the past few decades, and allowed me to eliminate one more emotional distraction regarding my management of risk in trading, at the track, or at the poker table. I simply denied the existence of luck for the past 30 years and chalked up all occurrences to probability.

About a week ago, my lovely wife, who's assimilated a lot of knowledge about trading through osmosis, came out with a startling statement regarding luck. We were discussing her illness when she blurted out, "You know, luck is a zero sum game." She made that profound statement at a time when I was vulnerable, and it got my mind spinning. I started to revisit a few thoughts about luck, and the meaning of luck. For simplicity's sake, I decided to define luck as a positive outcome to an event, random or otherwise, and bad luck as the opposite. I saw that my wife had a good point, provided that luck exists in the first place. She went on discussing that rain might cause good luck for the farmer while at the same time cause bad luck for the concert promoter who's outdoor concert was rained out. She gave about 10 more like examples of good luck/bad luck, and they all ended up having a zero sum, canceling each other out. However, I brought up the concept where one might have good luck, and the opposing party did not have bad luck, or merely had a case of lesser good luck. I mentioned a poker table where there was one big winner, four smaller winners, and one loser. I revisited the rain being good for the farmer, but too much rain might be bad. My lovely wife brilliantly speculated that there might be a big clearing house somewhere in the universe that dealt with luck, transferring the luck to the clearing house and doling the good and bad to random parties. A cosmic Karmic clearing house, so to speak. The clearing house analogy got to me, as I didn't even know that she knew what the function of an exchange clearing house was. All of this philosophical discussion finally got to her, tired her out, and she finally had to get some needed rest. Meanwhile, I was left with something very insightful to ponder, that zero sum concept of luck. In my usual attempt at avoidance and to remain dispassionate, I got back to my sugar position. Someday, I better find that old journal and revisit that proof.

Kim Zussman cautions:

We attempt to apply Statistics to markets because we see an analogy between markets and gambling. You bet when the deck is rich; count the cards and you will know.

But what if the dealer of the markets:

1. Shuffles under the table or may not shuffle - you cannot know (without inside info)

2. Might be using more than one deck

3. Sometimes uses a deck which favors your opponents

4. Usually favors you but occasionally ruins you

5. Knows that you need the action and abuses this knowledge

6. Knows that you will exploit your knowledge of him to others, especially the weak, ignorant, and women

Henry Gifford writes:

Simple proof that luck doesn't exist: You can't measure it. 

J.T. Holley adds:

The key to quantifying luck is (to paraphrase Thomas Jefferson) "the harder I work, the luckier I get".

If I was going to quantify luck this is where I would start going forward.

Those that have windfall luck from pure chance without doing anything usually lose the benefit within a short time it seems to me. Those on the other hand that receive a windfall from hard/smart work usually compound it from that point.

Vince Fulco agrees:

In his latest book, GM Gary Kasparov harps on this point.

"One interesting, and humbling thing I've noticed while analyzing my own games for publication is how poor some of the ideas I prepared really were…Only a fraction of these ideas every saw the light of day, either because my opponent didn't fall into my trap or because I found a better variation to play. Now I see that in many cases that was not a bad thing….This kind of preparation served me well in a way I never quite appreciated while I was working on it with such determination. These periods of intense preparation were rewarded with good results–even when I didn't end up utilizing the fruits of my labors. There was an almost mystical correlation between work and achievement, with no direct tie between them.

There is also a practical benefit to "wasted" effort. Work leads to knowledge, and knowledge is never wasted…"

Adam Robinson adds:

This sentiment echoes that of another strategist, General Eisenhower: "In preparing for battle I have found that plans are useless, but planning is indispensable."

Perhaps Kasparov romanticizes, however, in the "mystical" lack of correlation between his preparation and his later results. Surely having immersed himself in a position or a variation for some hard thinking, even though over the board he played "something different," he subconconsciously gained insights that facilitated his over-the-board analysis.

Writers experience this phenomenon all the time. You write something, read it over, and then scrap it and write something "completely different" that you realize now was what you meant to say all along. But you couldn't have gotten to that insight without first going down the "blind alley." I once scrapped an entire book manuscript and rewrote it from scratch for the same reason.

Alan Millhone relates it to checkers and stocks:

The late Checker World Champion, Tom Wiswell,  once told me to always make your best move in a game and never assume your opponent will make anything but their best move each time it is their turn. Play for superior position in your game. Luck comes to those who are well prepared.

Being prepared in the Market would be no exception. In Checkers I study past games of top players, keep a hand written manuscript , have a large Checker library for reference. Luck is when preparation meets opportunity.

In the Market one has to know your stock in every detail to make effective trades (like good moves in a Checker game).

The late and great Vince Lombardi said it best, " Luck is the residue of preparation ".
 

Sam Marx makes a distinction:

I will have to admit that my two most profitable moves in my lifetime were in investments and they were because of luck, also they were relatively cheap and I held them for a long time.

My success in trading, however, was not luck but based almost entirely on probabilities.

Investments vs. Trading. Perhaps luck plays a greater part with investments than trading and we should make that distinction.

 

Jan

9

McDonaldsJust caught on the news that Mc Donalds will add a 'coffee bar' and make more dramatic changes to their drink menu than they have in the past 30 years. I enjoy their Bravo coffee and am sure I will enjoy the drink additions when they reach my area. Mc Donalds is apparently still setting the pace in many areas as it was also announced that Starbucks now plans to make changes.

Sam Marx adds:

Although Starbucks gets a different niche of customers, this not good news for Starbucks .

A coffee bar and wi-fi at McDonalds, then Starbucks really has a problem.

Adam Robinson reflects:

I've always believed that the ethos of a corporation pervades, DNA-like, throughout all manifestations of the corporation, however small the "cell." If you want to discover the values of a company, you can look anywhere, from its choice of stationery down to the cleanliness of its floors.

Back to Starbucks. It was telling for me regarding the company's values that, living as I do five blocks from the former World Trade Center, I was shocked that in the days following, when rescue workers, many of them volunteers, flooded the area to begin cleanup, the local Starbucks was selling bottles of water. I'm as much a capitalist as anyone, but the outrage this opportunism occasioned in the local community, and subsequent bad publicity — Starbucks quickly reversed its policy and began handing out bottles for free – rankles to this day. The positive publicity it could have garnered by donating the water to relief workers would have more than paid for the negligible profits "sacrificed."

Ray Kroc was fanatic about cleaning his stores, and making everything perfect. Moreover, McDonald's franchisees are a powerful force for innovation and market research. I doubt that Starbucks has any such credo. And were I a fundamental investor, I'd bet on McDonald's in the race with Starbucks.

Ryan Carlson adds:

A worthy read about McDonald's is Ray Kroc's Grinding It Out. My favorite passage:

The key element in these individual success stories and of McDonald's itself, is not knack or education, it's determination.  This is expressed very well in my favorite homily: 'Press On: Nothing in the world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent.'

Henry Gifford dissents:

Starbucks and McDonalds offer entirely different products in terms of the cultural experience they sell.

On Broadway in Manhattan, two blocks from me, there is usually a homeless person "working the door" at the McDonald's, opening the door for customers and asking for spare change. Once McDonald's put a guy with a bow tie there to open the door for free, but that didn't last long, and the homeless guy is there every day. Also, the workers in McDonalds don't hesitate to stand around and chat and ignore customers.

At Starbucks a block away I've never seen a homeless person "working the door," (nor at any of the other stores nearby), I don't see homeless people sitting there, and the workers have a spring in their step.

Jim Rogers counters:

As someone whose first career was in the hospitality industry, I can state that McDonald's moves markets in more ways than one.

The difference in demographics, however, is a present condition and certainly not a necessary condition. McDonald's has always put its eggs in two baskets: families (especially those with small children) and value. In the past, their offerings were weighted more heavily on the family side of the spectrum. Now, thanks to a number of cultural shifts (including those driven by Starbucks), McDonald's has realized that they can capitalize on the public's perception of additional value. Before, it was all about quantity (the Super-size phenomenon). Now, it's about quality (better coffee, more aesthetically pleasing decor, fresher menu items). In the past 24 months, the majority of McDonald's top line revenue growth has been driven by menu items at the top of the price scale, especially new salad offerings. There are a couple of interesting points that McDonald's has embraced: the masses (or at least a historically large percentage of the masses) will pay for quality, and design makes a difference. It made a difference in attracting the kids thirty years ago, and now it's making a difference as it re-attracts adults (with or without children) with Wi-Fi, coffee, and more pleasing decor.

Marion Dreyfus opines:

Whatever the relative merits or demerits of the individual loci, the Starbucks habituee will not 'descend' to the perceived downmarket of McD's, which is a brand-association drummed into our consciousness by millions of ad messages over decades. The food may be better, the prices definitively so, at McD's, but the smart set will not cotton to the overbright, plastic-dominated perceived lower-ranking environment of kid-friendly McD's.

The escalation of prices for a simple beverage to unheard-of stratospheres is one thing that has, to date, ensured the rarefied perception of Starbuck's as being compatible with the upward-striving status-jumper.

So unless McD's radically alters its branding, the trendoids will find it distasteful to step lively in those swinging doors, even if their coffee tastes more acidic and sets them back more by a factor of twice or thrice the McD's coffee.

Ken Smith comments:

Ronald McDonald is five blocks east of me in Seattle, a short walk downhill a ways. Property they have is also just a short walk uphill to Childrens' Hospital. Parents can stay at Ronald's place while visiting kids, many with cancer. Ronald's facility is commendable for its architecture. One can have nothing but praise for Mr. Ronald, whose plastic body is standing out front of the facility, smiling with welcome. Kids love him.

Vitaliy N. Katsenelson analyzes:

SBUX stock is transitioning from 'growth' to 'value' investors. However, it is not cheap enough for value guys. At least not yet. Also, with current news cycle it will likely see the other extreme of its valuation. In the not so distant future it will probably have to rationalize its store base, close some underperforming stores and slow its growth expansion.

Jim Rogers notes:

Fast-food restaurants, due to their staffing policies, are much more likely to employ legal immigrants than you might think. The biggest offenders in the food world for using illegal labor: high-end restaurants, because they lack the institutional oversight and back-office support to adequately check a lot of prep cook and porter staff applications (and some are simply dishonest). If you're looking for a trade opportunity in the event of some strict anti-immigration policy, short higher ticket restaurant groups.

Scott Brooks writes:

McDonalds will have to work hard to overcome their persona. They have cultivated that image for a long time. I have often joked (with an air seriousness to it) that one of the greatest inventions/innovations of the 20th century was the McDonalds Playland!
 
I absolutely hate the food at McDonalds and will move heaven and earth to not eat there. But my kids like it. So when the wife needs a break and the kids want to go play, I'll take them to McDonalds, buy a few Happy Meals and let the kids play and eat.
 
Actually, they don't so much eat as graze. They play, come back and grab a few fries and bite or two of their burger/McNuggets and go back to playing.
 
As much as I don't like the food at McDonalds, they are an incredibly innovative company that I respect immensely. And with their distribution chain and the demographics of America changing, don't underestimate what McDonalds is capable of.
 
That clown may look stupid, but underneath there is a shrewd businessman!

Nigel Davies ponders:

I'm just wondering what the real appeal of McDonalds is and what really gets people in the doors.

I often eat at McDonalds during tournaments because there's usually one around, probably they won't poison me and if they do (and I live) I can sue them.

On the other hand my five year old son much prefers the relatively civilised atmosphere of Pizza Hut, so much so that I can use the 'Would you like to go to McDonalds for lunch?' gambit as a threat. Now it turns out he quite likes pubs that do food, but the big thing here was getting him in the door and outside his comfort zone. Now he does miss the balloons but there again he's taken a liking to turkey.

So it seems to me that a lot of this is down to parental choice, the main driver here being cost. Of course most parents are going to be struck by severe pangs of guilt should there be even a whiff of a rumour that the food served up is unhealthy. So with BSE (Mad Cow Disease)/cholesterol etc appearing on the horizon, it was inevitable that McDonalds would take a hit until it overhauled its menus and image.

In this respect I see the coffee/WiFi as being a really clever means of making them look like Starbucks and feeding off the modern, trendy and healthy image of the coffee house chains. But are they a 'competitor'? I really don't see it, and I don't see a Starbucks denizen suddenly switching to McDonalds because of the cost. To me it looks more like an image thing to get the old customers back in the doors.

Julian Rowberry submits:

Starbucks never really caught on here in Australia. Its brand name and attempt at exporting US culture is a tad brash for the local market. Plus there's already a vibrant cafe scene. The Maccas Cafe has been here for years. It's aiming at the fast and convenient 'healthy eating' market that companies such as Subway feed on. Not branded wanker latte drinkers.

Alston Mabry recounts:

Burger KingAt Burger King the other day (I'm not a big fan of fast food, but I am a Coke addict, and my dogs love the burgers on the dollar menu), I hit the drive-thru, and when I pulled up to the window, the Latina there said they needed to cook the burgers and would I mind pulling into the parking lot in front for about three minutes (they know their cooking times). No problem. I don't mind waiting in the car because I always have a good book to listen to, this time Adventure Capitalist. I'm listening away, and the pooches are quiet in the back, when I notice it's been almost ten minutes. So I go back through the drive-thru, and there is a young guy at the window this time. I start to explain, and he thinks I'm placing an order. His English is good, but he is obviously from Mexico or Central America. I show him my drink and the ticket and he gets it and starts rattling away in Spanish with the staff. I realize he is the shift manager. He comes back, apologizing profusely, and explains that they accidentally gave my food to somebody else who was also waiting, that they will cook fresh burgers for me and that he will bring them out to me personally. I think he was worried that I would be angry, but I wasn't at all. We park again, and a few minutes later he appears with the food and apologized otra vez.

The point of the story is this young guy. He was a good-looking kid, maybe twenty. He was running the show, working hard on his English, taking reponsibility for the results, apologizing for mistakes and personally delivering the goods. And here was Burger King providing the structure for him to be successful. Not a dead-end job at all, not for this guy. I was very impressed.

Scott Brooks adds:

I had an funny thing happen in fast food to me in about 1985. I was a manager of a Taco Bell, putting myself through college. We had hired a new girl who had previously worked at Burger King. It was her first day and I had her working the drive-thru.
 
The drive thru "dings" with her very first customer. She says into the microphone: "Welcome to Burger King, can I help you." I thought it was pretty funny, she thought it was pretty funny, but the guy in the drive-thru began laughing hilariously.
 
But he placed his order and pulled to the window. The reason he was laughing so hard? It turns out he was the guy who owned the Burger King where she used to work.

Dec

3

PawnI was at a pawn shop today looking at a couple of safes. The place was super busy and the owner ran out of cash while I was there and had to run to the bank for more greenbacks. I overheard one conversation where a fellow pawned some guns for $1,000 and in 30 days he owes $1,200 to redeem his pawn ticket. Business must be good, as the owner drives a new Maserati convertible. At one time years back I had considered a pawn shop and still have forms from the ATF for handling firearms. I have a good working knowledge of coins, stamps, rifles, handguns and other things of value. A pawn shop is somewhat dangerous and you have to give the local police a list every day of what you take on pawn. Always a chance some items might be stolen and you will have to surrender them if proven to be another's property. I guess the guy is entitled to such usurious interest rates for the risk he takes. I will always remember the classic black and white film The Pawnbroker, starring the late Rod Steiger.

Henry Gifford remarks:   

In New York City the government looks out for the consumer by passing laws that limit the interest rate pawnbrokers can charge. Thus there are approximately zero pawnshops in New York City. Hooray for the guy in Ohio charging whatever people are willing to pay!

Nov

18

Orange CoverallsFrom my small part of the globe (Belpre, Ohio) I can see the economy getting tighter for many. The ketchup bottle remains on the counter in an inverted fashion. My being-evicted renter (Nov. 30 at 2:00 PM is the eviction court date) has not been back to the unit for a month. I can tell because I put a penny in the door when closed in a certain way, so when the door is opened it falls and I know he has returned. My new smoke detector was hanging over his bedroom door (I can see this through his curtainless window); now it is on the bedroom floor. In Ohio, there's nothing I can do till I get him in court and he is evicted by the judge — then I get the unit back that day. The other night I noticed a late model Cadillac with Texas plates in front of his door and a 'donut' spare in place on one of the car's rear tires. I called the police to come and check the car out and found that my being-evicted renter gave his key to his cousin from Texas and let him move into the unit! Nothing I can do, even though the rental agreement is in the one person's name only. The police ran the Texas plates and 'rousted' the fellow as to why he was in the unit. I was standing there and he told the police and me that his cousin gave him the key and that he had no place to stay (homeless). The young fellow even apologized to me for being there! Then last night a deputy sheriff drove through the property and I asked him who he was looking for and he told me (fellow I am evicting). Guess he was a 'no show' in court for underage consumption and resisting arrest a time back. Things have gone from bad to worse for this young man. That evening he came back onto the property with another fellow to pick up the Texas cousin at my unit and I called the police. They arrived and took the fellow away in cuffs. The fellow from Texas is broke, no place to stay. Being-evicted renter may appear for his eviction hearing in prison orange coveralls. I see the economy tighten for people I rent to, and, comparing notes, other rental property owners have similar stories. Real estate is still a great investment — but not for everyone!

Henry Gifford remarks:

Interesting lesson for all in your rental headaches. I had some good, some bad tenants until I started using a broker to find tenants. They found only good ones. People with more time than money scour the classified ads, while people with lives use a broker. It's the best filtering mechanism around.

I had a tenant rent his mailbox to a drug dealer who stabbed me in the chest, and he's still in the apartment. When I was an active landlord, a really "clean" eviction case flew through the NYC courts in about a year if uncontested, longer if contested, which basically meant showing up. Sublets to non-payers could take a couple of years, with of course huge legal fees that cost more per month than several other tenants were paying. You have it easy out there in Ohio!

Ken Smith notes:

In Seattle a rental house can have up to 12 occupants, if I am correct on this. So when a renter is short of money he can advertise for people to share his domicile. Renter has the lease and can sublease. There are ways out of being evicted if willing to share. Place across street from me once had 12 occupants, all moving in to assist with the rent after the original lease holder lost his job. They moved in incrementally. First one, then a couple, then a mom with two kids, etc. 

Sep

24

Hedge Funds and Private Equity Alter Career Calculus

“I don’t think you will see M.B.A.’s less represented in executive suites, but you may see M.B.A.’s less represented in the lists of the world’s richest people,” Professor Schmalensee says.

So is business school a waste of time, or worth it for a young person starting out in a career in finance?

Peter Earle replies:

Getting an MBA was helpful for me as my academic background was in Comp Sci and History and, despite having read every book I could get my hands on, there were many gaps I needed to fill. Plus — although far less than 10 or 15 years ago — I'm told that for a sizeable number of finance/economics/business positions it remains one of the criteria used by HR professionals to screen a large stack of resumes on a "first pass" before digging deeper.
 
I wouldn't describe it as a waste of time, but in retrospect my career wouldn't have been much different without it. Your mileage may vary.

James Lackey asks:

What is the outcome you desire? If you want to work for Goldman you'd better start early to get into Harvard. If you want to work for the government, make connections early, be a clerk. The military, do ROTC. If you intend on working for yourself, it's best to get started early.

Without Vic and Laurel and their circle of influence, many of us would have missed out on the contacts we have made. To find a circle of erudite benevolent friends, perhaps again the Ivy League is the place to be. I was very lucky to be at the right place at the right time to meet Vic and Laurel.

What is the point of business school or being a businessman? What is your definition of success? Mine is the ability to do exactly what I love to do as a career, profit from meaningful work. Yet the huge catch: I do not want to answer to anyone.

Alston Mabry writes:

These days one must also be wary of the University of Phoenix effect. The Apollo Group has made a pile of money offering distance learning courses and degrees, and now nearly every traditional higher-ed institution is trying to compete. Distance learning wasn't invented by Phoenix, but they have used it to change the industry.

One upshot of this is the lowering of standards in many situations, especially when a degree program can be offered online and/or at night, to working professionals whose employers are willing to foot the bill. There is an incentive for the students to just "get the degree," and a big incentive for the institution to just collect the fees and definitely not to flunk anybody. Actual education, learning takes a back seat.

Henry Gifford writes:

A few years ago I spent some time at the business school at Columbia University. I was studying math for a few years, in a different building, but when my classmates wanted to study together, they usually wanted to meet in the library at the business school, thus we spent a lot of time there. The male students said they wanted to study there because the females there were better looking than elsewhere on campus. The female students said they wanted to study there because the library was the nicest on campus, and the male students said the females wanted to be there to meet a male who had high earning potential.

I sometimes read the student newspaper for the business school, and attended a lecture or two, which I think gave me some sense of what was going on. My clearest memory was of an article about a business school trip to an African country. The first day the students met with an economics minister, the next day they went on a tour of a coffee roasting facility, and the third day they went on a tour of the local Coca-Cola bottling plant, where their van got stuck in the mud. The reporter was skillful in vividly describing the complicated interactions and various stregnths and weaknesses of the different people involved with pushing the van. Then they spent the next five days at a resort on the coast, and the article ended with a request for donations to send money to help the country out of its endless cycle of corruption and poverty.
 
AfriqueI wrote in suggesting the best way to help the country out of poverty would be for someone to write a business school newspaper column analyzing the various stocks offered for sale in that coutry's stock market. The column could discourage buying stock of companies run by less honest management, and encourage each student to buy five or ten dollars worth of other stocks, thereby creating a source of income that the local corrupt politicians had little power over, and a source of experience and possible profit for the business school students. For some reason my letter went unpublished.
 
The newspaper also made it clear that students in each class were put into small groups, to encourage stronger connections between students during school, and after, when they could help each other get hired or promoted. There was also a lot of mention of the positions held by graduates, implying the purpose of the school was to have alumni provide a leg up for recent graduates. I saw little or no mention in the newspaper of actual business principles, theory, strategy, management, or sources of information on these topics.
 
I was left with the feeling that it was a large fraternity house subdivided into smaller clubs, which served mainly to prepare people for corporate culture — the right way to act, how to talk without saying anything, when it was neither appropriate to be silent, how to maneuver through the office/group politics, whom to challenge and whom to back down from, etc. All the skills nescessary to survive in a large organization, obtain connections that would be useful there, and have a chance to start at a level significantly above the bottom. I thought the school would be very worthwhile for anyone interested in those things.

Albert remarks:

For me B-school has provided an invaluable education. Whether it helps with job searches in the future I can't say. But I'm coming out understanding so much more of why the world works the way that it does than I did when I started.
 
I will say too that for a person who goes to a good school full time, the recruiting benifits are enormous in the industries that respect an MBA degree. But it is critical for a person going full time to go in knowing where they want to go afterwards as summer internship recruitment starts in the first few weeks of the first year and typically the summer internship leads to an industry job the following year.
 
So, like everything, it depend what you want to do with the degree.

Vin Humbert writes:

I've just started a Masters in Financial Economics programme at Oxford. I think the curriculum (as well as the physical surroundings, which are lovely) will be a good backdrop for my current stage as a student of the markets — after several years of balancing a law career with studying the markets, I'm moving towards being a full-time trader.

Orientation started today so I can't really say too much yet about the extent to which the programme is meeting my expectations. It's a pity they use MATLAB instead of R — but just as musical training in one instrument can have benefits on another instrument, I think the MATLAB finger exercises will be useful.

And, indeed, just as Albert says, classes haven't even properly begun yet and I am already supposed to be looking for a job for after my graduation in July!

Jul

2

 Oil is again trading at over $70 per barrel. However, as I understand it we (the US) have more oil in four states than there is in Saudi Arabia, locked in shale, and it can be extracted profitably at less than $35 per barrel.

Meanwhile the U.S. is pursuing and subsidizing ethanol from corn, driving up corn and meat prices. I think that a policy of extracting oil from shale should be our primary policy. What am I missing?

Of course, more than 30 Senators are from farm states and a policy of oil from shale, tar sands (under $30/barrel), or coal ($40/barrel) would drive down oil prices.

Jaime Klein writes:

Exploiting shale requires immense investments as well as a change in environmental regulations. Historically, oil markets suffer from cycles of overproduction followed by tight supply (like recent years). Investment in oil production has a long maturation period and is very risky. Any number of events, such as an outbreak of stability in Iraq, opening up Iran to foreign investments in oil, Hugo Chavez retired by a military coup, strengthening of demand destruction (in many developed countries oil demand is falling), could cause crude prices to collapse and then settle at its historical level (maybe half of its current price). I am shorting oil.

Sam Marx replies: 

If oil goes below $50, Saudi Arabia will cut production as it has in the past.

Alan Millhone comments:

Yes, then a 'created' scarcity. Alternative fuels, hybrid cars, etc. have been 'beat around' for years, but little done. In Vegas they have built an elevated monorail from MGM to the Sahara and talk is to extend it all the way to the airport. Taxi drivers are against this, but something has to be done to ease traffic congestion and fuel consumption in one isolated area of the US. America has always had a love affair with the automobile.

In Europe you can get a passenger train to about any location and buses and subways are readily available. I drove in Paris once and quickly realized I would not want to have a car there. Problem is not many of us are willing to 'cut back' on our driving. 

Sam Marx writes:

I believe that the only "alternative" fuel that will work is oil produced in this country. That means drilling in Alaska, offshore, and very deep drilling on land. Aside from that are oil produced from shale, coal, and tar sands (Canada). Money and necessity should be the solution to environmental problems.

I believe that by hybrid cars you mean they also use ethanol. For many reasons I don't believe that ethanol is the solution. As for smaller cars, it is my understanding that since 1972, an additional 50,000 people have died in auto accidents in the U.S. because they were in a small car, but would've survived if protected by being in a larger car.

During WW II , Germany had to resort to oil from coal. After everything is considered and there is rational leadership in this country, willing to stand up to big oil, I believe we will have to resort to oil from shale, tar sand, or coal also.

I don't believe that there is a conspiracy by big oil to drive up prices, but I do believe that they don't want prices to come down and oil from shale, tar sands, or coal would do that. 

Henry Gifford writes:

A man named Peter Judd did a study of the amount of fuel used to make heat and hot water for each of thousands of apartments in New York City in the 1980s. He divided the buildings into five categories: old law tenements (pre 1901), new law tenements, pre WW2, post war, and post 1974 oil embargo. The average use for each category was about the same, except for some improvement in the post 74 buildings, which when credit for more bulk and therefore a lower surface area/floor area ratio is considered, means there has been approximately zero progress in 100 years.

The most interesting thing he discovered was the spread between the best and the worst buildings - about 700% when the unusually high and low consumption buildings were tossed out of the mix. The spread persisted in all categories.

The main exception were the buildings gut renovated in the 1980s, which had new double pane windows, insulation for the first time, and new boilers and controls. They used 50% more fuel than the average of the existing housing stock. Since they were renovated by the government, and Peter was a government employee, he was moved to a do-nothing job, and soon left. His counting skills are now put to use in producing off-off-Broadway theatre.

The lesson I took from this is that some buildings use 1/7 of what others use, while providing better comfort. Meanwhile, this is all done unintentionally, as it wasn't until the mid 1990s that anyone even claimed to be making energy efficient houses in NYC. The extra cost of course was zero. I think this argues that there is a lot of potential gain from conservation.

It turns out there is a field called "Building Science" which is a study of the factors which effect comfort and building durability and energy use, which is widely ignored by the industry. But the science to explain this exists, as does the counting to show what is possible. Knowledge of these things has led me to believe that buildings could be built that use 10% or 20% of the energy that existing, average buildings use, and be built this way for no extra cost. I have done this, and am one of the only people in the field who shows fuel bills to back up claims. Of course, zero extra cost has its own problems, not the least of which is that there are approximately four people in the US who work on energy efficiency in buildings and are not paid by the government. This causes many conversations to start with "money is available for…" instead of "energy can be saved by…", which of course is an impediment to innovation.

I cannot predict how widespread sound building practices will become, but have no doubt that from a technical perspective, all the necessary technology has existed for decades, and is currently for sale in Home Depot. It's just that the industry that knows how to design and build such buildings mostly does not exist.

As for oil from coal, it is true the Germans did it, but at a high cost, and only in the face of severe shortages. The rumor that fuel was so scarce in Germany that the first jet planes in history were towed to the runway with horses is simply not true. They used cows, because the army was using all the horses. I think fuel will get more scarce before oil shale is economically viable.

One of the costs is the energy used in the process. The Canadians say that it will take the energy from two barrels of oil shale to produce a third barrel. Perhaps in our milder climate the numbers will be a bit better, but probably not by much. At best, it will be a costly and difficult process. 

May

24

 Real time substitutions are taking place in commodities due to NYC Mayor Bloomberg's schedule for all NYC taxis to be hybrids by 2012, and also the increased presence and use of other energy sources such as solar and wind. I wonder about the dire predictions of $100 per barrel oil.

I also heard today the suggestion that if U.S. drivers switched to the equivalent European models, one year's consumption Chinese oil would be saved. I wonder about countries such as Venezuela and Russia, which are heavily oil-dependent and moving in non-market friendly directions.

Henry Gifford replies:

Yes, things are changing a little. Many NYC taxis are already hybrids, the jeep looking ones. As they are driven more than other vehicles, the payback is more attractive, with drivers reporting huge savings, especially when the air conditioning is off. Looked at another way, a non-taxi hybrid sits idle most of 24 hours, yielding no payback.

Yesterday I heard about a New York State agency paying about 2/3 of the purchase cost of a solar system that has a 94-year payback. Solar is nice, but expensive.

Wind in urban areas is mostly for show, as velocities close to the earth's surface are lower than a few dozen meters, and it is hard to harvest energy from the turbulent wind currents near buildings.

This all strikes me as two examples of the government using our money for things that don't pay well. That is unless the systems installed result in property tax increases exceeding the value of the energy saved. This isn't unheard of. It would be one example of the government partly taking credit for a change already in progress, and perhaps slowing the change down in the process, by encouraging taxi owners to wait for the government to set up the plan to pay them for what some are already doing.

May

7

 There are many positive aspects of insurance and annuities to consider, most of them revolving around peace of mind, at a price (usually a high price).

I have several senior citizen clients that are in annuities that are loaded with living (income) and death benefit guarantees. These benefits are quite pricey when you break them down. Really not worth the price, and people like Jane Bryant Quinn always vilify them, and rightly so. Most of them are mis-sold by salesman (who happened to have passed a Series 6 or 7 exam) to clients who don't understand them.

However, there are some benefits that need to be considered. I have clients that love the annuities I have them in (I use strictly no-load annuities (truly no-load, no-load in and no-load out, complete liquidity). These annuities allow them to stay in the markets when they otherwise couldn't stomach any volatility whatsoever. It's really just a peace of mind thing for them. I could get them a higher return if I managed their assets directly, but in reality, they wouldn't invest in the stock market if it weren't for the guarantees.

So the bottom line for me with annuities are this: Don't use them unless you really need the guarantees associated with them or if you plan to hold them for at least 8-12 years (the break even point between tax deferral and eventually ordinary income vs. paying capital gains tax as you go).

Life insurance is a complicated subject. If clients need "income protection in the event of premature death," then they need low-cost term insurance. They can get it over the Internet or through a good insurance broker.

A lot of salesmen try to sell insurance as saving vehicles. This kind of life insurance is 95%+ garbage (just as 95% of annuities are garbage). Don't fall for this pitch unless the person recommending it is a real planner who knows what he's doing and is using a stripped out no-load or low-load policy. And If they take this route, then they need to do a maximum funding/minimum face amount policy that doesn't violate the MEC laws. You want to make sure that the contract is not a MEC (Modified Endowment Contract). Furthermore, they need to make sure the contract offers zero interest loans (sometimes called a "wash loan"). And they need to be sure that they can afford to make the deposits that they commit (under a max funding/min face scenario).

Henry Gifford adds:

Once upon a time an annuity was an arrangement where a person paid money to an insurance company, typically a lump sum, and in exchange received periodic payments for life, sometimes starting immediately, sometimes starting at a future date.

The insurance company could use actuarial tables to determine that they were promising an income stream that on average, with interest figured in, was worth less than what they were selling it for. The same tables could be used to show the customer that if he lived longer than the average for a person in his category, he would receive a payout worth more than he had paid in. Thus for the customer it was similar to joining a pension arrangement, where people dying early subsidize those who lived longer, and all participants could be guaranteed income for life.

Things are not that simple any more. "Annuity" is now used to describe a dizzying array of products, few of which guarantee anything for life. Finding a simple description now is I think not a realistic goal.

Ray Humbert contributes:

The moving parts from an insurance company's perspective: mortality, interest, lapses, expenses and profits and taxes. It's all based on the probability of surviving (both actual and as a policyholder), and the time value of money. The buyer buys because his time of death is a tail risk tragedy and he is willing to pay more for less risk — a risk premium. But the real kicker is that any death benefit is generally tax-free and any cash surrender value also accumulates tax-free.

In general it is best to have the most complete underwriting that your health can support without getting "dinged." You want to be in the "pool" with the healthiest, least likely to die people to save mortality cost. Generally people like to pay a level premium, but this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value. Whole life has cash value, which has a margin of safety for the insurance company, so they often share some of the "good experience" in a dividend. Universal life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load,", i.e. an surrender charge.

One of the frustrating things is that investments by insurance companies are highly regulated, and crazily taxed. Hence, it is hard for a insurance company to get you "efficient frontier" returns. If they are taking the investment risk, the regulators see it as there duty to make sure they do things conservatively, to protect very long term policyholders. But like most regulations, the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from tough regulations. Further, any time taxes are involved, everyone wants more than his share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have "tax-free accumulation." A deferred annuity is a tax-free build-up of a savings which you can latter "annuitize" (make it an income stream) which can be a set period, or for life, or a combination of guaranteed payments for X years to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly).

May

6

 I have been watching the Queen on the news and her day-to-day visits to the US. Her last visit was in 1956. The Queen has one of the finest collections of rare stamps. On occasion she will lend certain portions of this vast collection to World Philatelic events. She has been afforded the honour of collecting stamps and also having her likeness printed on many stamps. I wonder what she thinks about our new inflation proof US forever stamp. Speaking of stamps, our current 39-cent stamps go up a few pennies this month! Is the forever stamp a good investment over the long haul?

Henry Gifford writes:

Regarding the "forever" stamp vs. inflation, I have a narrow definition of inflation: the lowering of the value of money.

If the price of hamburgers goes up after an epidemic of hoof-and-mouth disease reduces the supply of beef while the demand does not change, the price increase probably reflects an increase in the value of beef. This is not inflation. Describing it as "beef price inflation" is a mishmash of two factors.

True, the factors cannot ever be separated any more than anyone can say with certainty why a stock goes up in price. But inflation can, and I think should, be used only to only describe a lowering of the "price" or value of money. I once started a collection of the various and conflicting definitions, and the wide variety of points supported by changing the definition to suit the situation, but was quickly overwhelmed.

Suffice to say that I think the most honest definition is the simplest: a lowering of the value of money. With regard to the stamps, if the value of delivering a letter does not change, buying "forever" stamps is a hedge against inflation, sort of like holding dollar stocks (39 cents of dollars) while also repeatedly buying call options on the price of the dollar, with the price of the calls equal to the opportunity cost of not investing the money elsewhere.

As the price of delivering a letter is simultaneously taxpayer subsidized and a protected monopoly, the actual value and its change over time is hard to judge, much less predict, as there has been no actual price data available since the government monopoly was started. The excuse was that it was necessary to thwart spying during the Civil War. Changing technology since then makes it hard to judge the change in value.

May

6

 Does anyone understand how the gears and levers of insurance and annuities work? For me, it's a MEGO subject that I'd like to understand better. Is there a good web reference, or can someone write a brief essay that outlines the moving parts?

For instance, what are the real economic aspects life insurance products (whole/term/universal)? I vaguely understand some or all of them involve embedded optionality (since the pay-in of premia is fixed in advance) especially wrt interest rates. Is there a quick analysis of the form "product X includes embedded long-bond optionality that the buyer typically pays 2 vols vig on"?

And how best to jumble together all the tax/risk/return/optionality aspects, without doing deep financial engineering? I'd love to have a brief (but informed) soundbite I could pass on to friends/family who ask me about such things, believing (erroneously) I'm knowledgable.  

Russ Humbert responds: 

The moving parts from a insurance companies perspective: Mortality, Interest, Lapses, Expenses and profits and taxes. Its all based on the probability of surviving (both actual and as a policyholder), the time value of money. The buyer, buys because his time of death is much more a tail risk tragedy and is willing to pay more for less risk, a risk premium. But the real kicker is that any death benefit is generally tax free and any cash surrender value also accumulates tax free.

And in general it is best to have the most complete underwriting that your health can withgo without getting "dinged". You want to be the "pool" with the healthiest, least likely to die people to save mortality cost.

Generally people like to pay a level premium.

But this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, this maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value.

Whole life has cash value which has a margin of safety for the ins. comp. so they often share some of the "good experience" in a dividend.

Universal Life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load" I.e. an surrender charge.

One of the frustrating things is that investment for insurance companies are highly regulated, and very crazily taxed. Hence, it is hard for a insurance company to get you "efficient frontier" returns. If they are taking the investment risk the regulators see it as there duty to make sure they do things conservatively, to protect very long term policyholder. But like most regulations the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from some tougher regulations.

Further, IMHO any time taxes vehicles are involved, everyone wants more than their share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have the "tax free accumulation". A deferred annuity is a tax free build-up of a savings which you can latter "annuitize" (make it an income stream which can be a set period or for life or a combination of guaranteed payments for x year to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly)

PV $1 annuity = sum of Prob survive(t) X appropriate discount rate(t). Payout = Premium /PV $1 annuity.

From Anon: 

The moving parts from insurance companies' perspective: Mortality, Interest, Lapses, Expenses and profits and taxes. It's all based on the probability of surviving (both actual and as a policyholder), the time value of money. The buyer buys because his time of death is much more a tail risk tragedy and is willing to pay more for less risk, a risk premium. But the real kicker is that any death benefit is generally tax-free and any cash surrender value also accumulates tax-free.

And in general it is best to have the most complete underwriting that your health can withgo without getting "dinged". You want to be the "pool" with the healthiest, least likely to die people to save mortality cost.

Generally people like to pay a level premium.

But this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, this maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value.

Whole life has cash value that has a margin of safety for the insurance company, so they often share some of the "good experience" in a dividend.

Universal Life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load", i.e., a surrender charge.

One of the frustrating things is that investment for insurance companies are highly regulated, and very crazily taxed. Hence, it is hard for an insurance company to get you "efficient frontier" returns. If they are taking the investment risk the regulators see it as their duty to make sure they do things conservatively, to protect very long-term policyholder. But like most regulations the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from some tougher regulations.

Further, IMHO any time taxes vehicles are involved, everyone wants more than their share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have the "tax free accumulation". A deferred annuity is a tax free build-up of a savings which you can latter "annuitize" (make it an income stream which can be a set period or for life or a combination of guaranteed payments for x year to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly).

PV $1 annuity = sum of Prob survive(t) X appropriate discount rate(t). Payout = Premium /PV $1 annuity.

From Henry Gifford:

The importance of the "lapses" part of the above description is what was apparently behind the commotion last year when investors were reported to be buying old people's policies from them before they died. What the investors apparently figured out was that the expected number of policies that "lapsed," that is, the policyholders didn't keep up the payments and thereby forfeited the benefits, enabled the insurance companies to promise rather large payouts. The investors planned to maintain the payments on 100% of the policies until the people died, thereby getting handsome returns. 

May

3

 Driving down Washington Boulevard here in Belpre I noted the local Speedway has just boosted their regular gas to $3.19. I hear on the news that fears are mounting that Iran may mine the Straits of Hormuz, and thus oil could approach $100.00 per barrel and gasoline might reach $5-6 per gallon. This will affect all of us to some degree. All of this may benefit my overall health as I am a bit too heavy and will begin to walk a little more. My walking and others who do the same might have a direct correlation to the Market! I will need a pair of good tennis shoes and if enough of us walk and buy shoes those companies will benefit and so will their stocks.

On saving fuel: The other night on the news a tip was given for saving some gas. Instead of going through to get that favorite Big Mac, it was recommended you park your car and go inside and get your carryout order. You will be saving fuel by not idling in line and get in some walking to boot. Others I am sure have their own tips to share.

Henry Gifford adds:

There are approximately two meaningful ways to save gasoline used to operate a car. One is to keep the tires inflated to the correct pressure. This is widely overlooked, and can save money and gas. The other way is to replace the air filter when it gets dirty, which saves the energy used to suck air through a dirty filter.

Otherwise, other than turning the engine off when possible, as described below, very little else can be done. The energy profile of a car is basically fixed the day it rolls off the assembly line.

Approx. 28% of the fuel is typically used while idling at red lights or in very slow traffic, when the overall efficiency is essentially zero. Gas/Electric hybrids avoid this, which is one of the ways they save fuel.

Apr

16

 The efficacy of white LEDs is about 12 to 19 lumens/Watt, which is much less than the 36 to 55 claimed by manufacturers. Compact florescents have efficacies 1.5 to 3 times higher than LEDs.It it said that compact florescents last indefinitely, which is far from true. The screw-in types last much longer than incandescent bulbs, but don't last forever, and their life is shortened by the fact that the "ballast," the electronic guts, is located very close to the bulb, thus the heat shortens its life.

It used to be true that compact florescents were expensive, gave off a harsh light, and could not be dimmed. But now the screw-ones cost less than $2.00 in quantity (not everyone agrees with this, but I'll sell anyone who doesn't believe it as many as he wants for $2.00 each).

The best deal is a real florescent fixture, as the reflector is shaped optimally for the bulb, and the ballast is remote, thus protected from the heat, and is seperate, so it doesn't need to be replaced when the bulb goes bad. The bulbs are available in five different colors and more and more of them are dimmable, especially those made by Phillips.

florescents are now hard to tell apart from incandescents without taking the fixture apart and looking, so energy geeks are resorting to using fancy light filters to tell them apart without climbing on a ladder.

Rich Bubb remarks:

Our firm has been using the spiral bulbs for five years. Recently I was in the room where we'd installed the earliest ones, and noticed an odd smell. Then the bulb burned out. Probably the mercury in the bulb vaporizing.

I didn't know they contained mercury at the time of the first burn-out. From now on we'll raise the windows and go outside to let the fumes dissipate. Maybe go get a cup of coffee in the meantime. 

Apr

15

"If You Think You Can Beat Buy and Hold, Try Looking at Taxes"

Standard and Poor's gives SP500 returns with and without dividends back to 1990. Here are the returns at year ends, without and with dividends:

date       1yr rt  total rt
12/1990 -0.066 -0.031
12/1991  0.263  0.305
12/1992  0.045  0.076
12/1993  0.071  0.101
12/1994 -0.015  0.013
12/1995  0.341  0.376
12/1996  0.203  0.230
12/1997  0.310  0.334
12/1998  0.267  0.286
12/1999  0.195  0.210
12/2000 -0.101 -0.091
12/2001 -0.130 -0.119
12/2002 -0.234 -0.221
12/2003  0.264  0.287
12/2004  0.090  0.109
12/2005  0.030  0.049
12/2006  0.136  0.158

Mr. B. Holder (BH) puts $100,000 into the SP500 index 1/1/90, reinvests dividends into the index at year end, and pays tax on dividends out of his salary as school janitor. BH sweeps into retardment 12/2006, and notices that without taxes his initial investment became $555,637, including reinvestment of $22,271 in dividends along the way.

For this exercise, let's assume that long-term capital gains and dividends are both taxed 20% (they are currently taxed less, have been taxed more in the past, and will no doubt be more in the future). When BH cashes out 12/06, he gets to contribute $91,128 and keeps
$464,510.

Also in 1990, recent refugee Natasha Otradeskaya (NO) plows $100,000 of hard stolen capital into a U.S. trading account. Like others from her country, NO has degrees in math, physics, and nuclear medicine, but unlike competitors in the US and A, does well enough with trading (after slippage, commissions, and opportunity costs) to exactly equal yearly SP500 returns including dividends. Exhausted after 16 years and 10^16 quantitative studies, she decides to look back at her results:

date      100000     P/L     tax        net
12/1990   96896   -3104       0
12/1991 126416  29520   7925  118491
12/1992 127526    1110    333  127193
12/1993 140004  12478   3743  136261
12/1994 138060   -1945        0  138060
12/1995 189939  51880 14980 174959
12/1996 215129  25190   7557 207572
12/1997 276825  61696 18509 258316
12/1998 332140  55315 16594 315546
12/1999 381941  49801 14940 367001
12/2000 333588 -48354        0 333588
12/2001 293938 -39650        0 293938
12/2002 228973 -64965        0 228973
12/2003 294665  65692        0 294665
12/2004 326724  32060        0 326724
12/2005 342770  16045        0 342770
12/2006 396907  54137   4490 392417 <<<<Final balance

NO trades full-time 100% of her account every year, and pays income tax of 30% on her gains (the calculation carries forward losses, which are balanced against future gains; which is the case for a trader who has no other income tax to offset capital losses. Note also that losses carried forward from 00-02 are not used up until 2006). Thus she is unable to reinvest what is lost to taxes, and these amounts do not compound.

In the end, BH cleans up: He gets paid an extra $72,093 for not doing studies or trading frequently, and uses it to order a new bride who happens to be NO's grand-niece from the old country.

J T Holley adds: 

The old gray mare ain't what she used to be. You can actually get no load low M&E annuities that aren't as bad as you would think. Most people think though that investing should be free and that one bp is too much.

Vanguard's isn't in the example above but its M&E is .20 basis points with a .10 basis point administration charge and the S&P 500 clone sub account is .44 expense, bringing the total to 74 beeps. Anyone counting this out remember that annuities are like mutual funds and take fees out daily on an annual basis.

I'll take the ordinary income later in life over the stg/ltg now and avoid Uncle Sam. Even with the 74 beep vig annually that is better than the taxable stg/ltg combination paying taxes now, that the S&P 500 tax toll can be annual. I like the compounding and pay later acting as a quasi spigot trust if you have enough time and persistence.

Steve is right though. There are tons of annuities that have a lot higher costs. The industry average is around 250 beeps in M&E and charges, but even these higher vigged charges show the tax deferral outperforming the pay as you go in a taxable account if you hold long enough to let it happen.

Also, annuities have a 10% penalty much like IRA's if you yank out before 59 ½, unless you 72T. I would recommend neither unless "liquidation" is really needed.

Mr. Sears might help us here. I'll defer all annuity and running knowledge to him.

Steve Leslie writes:

ETFs are not fairly new. Diamonds and Spiders have been around for a decade or more. And irrespective of their longevity if one's goal is to replicate an event using an ETF, what difference does it make how long they have been around? This is not Morningstar; as we know track records do not matter.

There is a big misunderstanding as to the elimination of estate tax law in 2010 and the questions surrounding it. The reason there is a gap in 2010 is that it is my understanding tax law cannot be written for more than 10 years. So it is clear that the next administration will rewrite the tax code. Who knows what they will come up with then?

There are some very low cost variable annuities which stripped down to the bare minimum may have an attractiveness. When I was a broker (sounds like my father) the lowest cost one we sold was the Nationwide Best of America. Still, be very careful that there are some pretty good back end charges if you redeem the annuity. I think there are some no load annuities with low M&E perhaps in the Vanguard family. M&E is mortality and expenses.

This is where all the hidden charges show up. You pay for that death benefit. And the charges are rarely below 1% and then you add management fees of the funds on top of that. The management fees can be higher in annuities if they are funds outside the annuities family of funds. You pay to play. And once again there is no stepped up cost basis on date of death. That is an extremely expensive thing to have the heirs have to face should that happen.

I still argue there is no perfect solution, however, ETFs stack up very well against no load index funds, in performance for expenses and after tax return ease of ownership and liquidity. One added thought; they are a heck of a lot easier to track the cost basis for reinvested dividends than mutual funds. You do not get average cost basis. First in first out, etc.

I am not sure about the dividends being left in cash as Mr. Sasmor suggests. I thought by definition they try to be as fully invested as possible. Not even open-end index mutual funds are fully invested at all times. They do by the mechanics of the machine have to keep some cash on hand. And in open ended mutual funds, when a run on liquidity happens they must sell stocks accordingly to handle redemptions. Whereas with closed end funds this does not happen. There may be times when closed end funds trade at a discount to the NAV. Open ended mutuals are marked to the market on the end of business. And purchases are restricted to last day's closing price.

Bill Rafter adds: 

Regularly I get an idea from an investment professional who typically does not do any quantitative research, but has a "hunch" that he thinks will work. More often than not the investment pro got the idea from some huckster. Investment professionals are really no different (nor less vulnerable) than the public at large. To keep the investment professional devoted to quality research, I have to disprove the cockamamie hunches, lest he wander off following outlandish ideas.

The latest is the "gravity idea" based on "celestial mechanics". Every good con job contains a certain amount of truth, and this one evokes Isaac Newton, Kepler, and some other luminaries. The celestial mechanics is BS to make the huckster sound important and establish him in an intellectual pecking order. I think this is something they teach in huckster school on the premise that the mark has to look up to the huckster.

The system the huckster is peddling is really just based on tides, which of course is a function of celestial mechanics. But neither the huckster nor the mark knows that. I can tell the huckster doesn't know that because he claims to use both the celestial cycles and the tides, which in his case is redundant.

The huckster uses tide schedules from a point in Delaware Bay. I cannot really find out why because all conversation has to go through the mark. Apparently the mark has told the huckster that he has had conversations with another one of his confidants (me) who is skeptical. This gets the huckster's back up: how dare the mark give any credibility to non-believers! Another lesson from huckster school: get indignant when challenged and threaten to cut off communications. The mark always wants what he cannot have.

The huckster really has the mark convinced. I try all sorts of arguments, like why we cannot find any evidence of these cycles using Fourier analysis. And if the idea were true, why isn't there more volatility during the "spring tides" when the earth is at perigee? However, I'm getting nowhere because the huckster has a track record with great performance. Of course there are reasons why he cannot show it, so no one has seen it.

Well I don't want to go searching for the Delaware Bay tide schedule. And since I live near the seashore, I have the Barnegat Light tide tables bookmarked on the PC. That data are neatly presented in a spreadsheet with the date and four columns representing the two daily high and low tides. The similarity with bar-chart data is overwhelming, so I copy the data, import it into my charting software and have it displayed as open, high, low and close. I send that chart back to the investment professional with my commentary that the highs on the 2nd of the month will be higher than the highs on the 16th, and the lows of the 23rd will be lower than the lows of the 9th.

At the end of the month the investment professional (i.e. the mark) gives me a call and tells me that my trading signals were right on target, and the gravity man (i.e. the huckster) complements me on having mastered the technique in such a short period of time. I know the trading signals did not work and I suspect that the huckster is now using me to validate his own importance. This must be another lesson from huckster class: if confronted with an outside challenge, turn the challenge around to support your own claims.

I have no choice but to have a personal meeting with the investment professional and show him exactly what I did, which takes about two minutes. He really doesn't want to believe me, but when he sees that my tidal signals did not work and then realizes that the gravity man is just playing him, I finally win him over.

Hey, anyone want to buy my gravity system?

Steve B. adds:

The con game is not so much about the con be it in financial services, health and beauty, or the red-hot real estate (mortgage) market. The con game is about the mark - the one who must get conned for the game to work. The con in this game has the advantage of instant feedback from the mark. The mark is spotted by the type of work he does, the kind of car he drives, his or her age. These are just general and to get specifics he needs to talk directly with the mark.

How is it that the con can come to know about us? We provide him the information via physics and other shamsters. But in this case we feel we are dealing with a respectable person and our guards are down. Basically, one starts with general statements and through feedback (verbal and body) the con figures out which of his general statements are specific to you.

We all have the desire to trust our fellow human and the con operates with this advantage. You may not always know when the con is on but if you feel the flattery (and a feeling you may miss the boat) then you may be a mark.

From Henry Gifford:

While it seems so many con games include some true physics in the story, the physics are usually redundant (as already mentioned) or not relevant. My favorite is energy-saving devices that incorporate the use of "bipolar" magnets. As all magnets have two poles, the statement is meaningless yet true. 

Mar

8

 One of the virtues of my recent vacation was that the market plunge caused me to watch prices every minute of the day while the family was playing. I found the most convenient price feed for me on CNBC which has streaming S&P futures prices and DJ every 30 seconds. The prices are interspersed with an orchestrated mélange of shows, news, and opinions from reporters, hosts, columnists, market mavens, scenes from the floor, self serving comments by investors with positions, mutual fund managers, live coverage of official meetings like the Fed before congress, and guest appearances by politicians.

As I have always eschewed reading any newspapers or watching TV, (Indeed four generations of my family have not owned a TV, and our kids frequently are asked at show and tell to describe what it's like not to have a TV in the house), I thought it might be appropriate for me to give some impressions of the coverage the same way that it might be valuable for a man from Mars to comment on the backdrop of human comings and goings.

My choice of CNBC was apparently fortuitous as this station is recognized as the leader in global business news. Time Warner Media states they reach 88 million households, a survey of financial workers shows that about 90% of them watch it at least once during the day. The profits of the station are about 250 million, and viewership of approximately 500,000 is apparently double from 2 years ago.

Influential people seem to recognize this and during the week that I watched, such luminaries as Hillary Clinton came on for a special message that foreign holdings of US debt should provide a wake up call for US vulnerability. Abbey Cohen gave a very thoughtful bullish prediction for US stocks the day after the crash and Warren Buffett himself was shown repeatedly talking down the US stock market because of its vulnerability to a hard landing, due to the twin deficits. All that was missing as far as I was concerned was an interview with the Palindrome himself stating that he was bearish on the dollar or stocks.

I have a theory that the public is always guided to do the wrong thing so that they will make a contribution to the market infrastructure and provide funds for the massive communication costs, buildings, salaries, brokerage house traders, dealers, hedge funds, and mutual funds that must survive in order for the whole ball of wax to continue. Thus, during the period I watched from Wednesday, February 28 to Saturday, March 3, which was sparked by the 4% decline on Tuesday, Feb 27 and a 5% decline in the market in a five-day week, I was particularly anxious to see how the public would be guided to take a bearish view.

As is well known, after big declines like this, the most successful investors take out their canes and hobble down to the street and buy. This is greeted on average with a 2.5% rise over the next 10 days, and smaller rises each of the next five days, as has been well documented in this space, my books, and the many that have noted the effect by counting independently or who have the ability to count it themselves, or talk to someone who has. I was not disappointed in my belief that much bearish guidance would be given. Indeed, two of my favorite techniques of propaganda pseudo talk were used prominently — namely the mystical perfect lie technique of causing magic to happen and then belittling ones abilities ('that key you lost 10 years ago that I just pulled out of the clouds doesn't count as evidence of my mystical abilities because I wasn't really trying to do it'), and the technique of the quote taken out of context.

The quote out of context was particularly salient on Wednesday as a chronic bear was interviewed about Ben Bernanke's testimony. Bernanke's testimony was the most bullish that I have ever heard from a Fed official. He stated that there was no liquidity crisis, that the economy was destined to improve over the next six months, and that there was no change in the economic data that would warrant a prediction a la Greenspan's 1/3 probability of recession. Yet the chronic bear was able to find one sentence in dozens of pages of testimony that he said showed how bearish the Fed was, in that it said that if the rate of real estate increase did not continue as it has in the past five years, that it was possible the amount of spending might not be buffered as much as it has in the past by this increase in wealth.

Similarly another chronic bear, who was greeted with an "every bear has his day" headline, emphasized that he wasn't really worried about China, which was the proximate cause of the decline on Tuesday morning but all the sub prime lenders were about to evaporate. A very nice climactic punch was thrown by a wild man coming on the stage at about one each day. Jim Cramer screamed that this was an amateur bear raid, that he couldn't really say how bad the subprime was because it would be indiscreet, and that he would have liked to see the Dow fall below 12,000 to really create fear.

The back and forth between the attractive female reporters who tried to hold him down as he screamed about how stupid everyone else was, and how he didn't care about the yen carry trade at all, made for a thrilling and highly romantic tête-à-tête. The excitement was enhanced by a distress call by the attractive other that, to make matters worse, the chronic bull Larry Kudlow was going to be on next, against the chronic bear forensic accountant.

I found watching the orchestrated performance of reaction to the market panic during the time that I listened that I could attribute the movements in the market itself to the content of the messages communicated.


When news of Hillary or Buffett was reported, or Herb Greenberg or other chronic bears spoke their piece, or Maria Bartiromo decried the latest earnings report, the market went down say 10 to 20 Dow points in the next fifteen minutes. When the venerable senior economic analyst, Joe Kernan or a Florida buy and holder, or Abbey Cohen talked, to say that it had all happened before, and in the fullness of time, that the decline wouldn't even be noticed, the market went up some 10 Dow points in the next 15 minutes. It would seem to be possible to profit from such moves by buying and selling during times when the market is on edge based on who is scheduled to talk.

I found the on the scene reports of Michael Santolli, from the floor of the Chicago Merc, very interesting. He managed to provide a good description of what people were saying about what caused the latest move in the market over the previous half hour. He was very good at maintaining a judicious manner in not forecasting anything. Indeed, during the time I watched, there was little attempt by anyone to try to provide a rudder, such as what generally happens after panics.

The consensus seemed to be that the decline had not yet reached 10% and it was likely that it had further to go on the downside before turning up later. Such communiqués go against the theory of rational expectations, which are true to the extent that if we think something is going to go up 10% by the end of the year, we're going to buy now, even if we think there's a chance that there might be some unpredictable bumps along the way. I found Maria Bartiromo a very knowledgeable and serious reporter. Her frowns, pouts, and cover the eyes bangs, seemed to inject a gentle scorn for the men she interviewed, as if she would like to give them a proper beating if only they weren't so foolish.

I understand that during the tech heydays of the 90s she had a much more engaging and cheerleading demeanor and she is to be complimented on this about face. This is also helpful to the market ecology as exactly the opposite would in my mind be more profitable to the viewers. Regardless, for me this added a very fine, exciting ambience when she came on at the beginning and end of each day with her somewhat denigrating, above the fray chastisements of those who would be long during this time of panic.

One of the ironies of my Florida viewing was that just when the market was at its most climactic bearishness, the shows would end, and a local commercial would be shown. The commercials all seemed to highlight the availability for one week only of personal loans without bank statement with an interest rate of 6%.

I found the rate more and more attractive as the market decline continued. The same for the Florida vacation homes available with 10 acres of land for just a $100 deposit. Also ironic was seeing the constant advertisements from someone whose research I find totally wanting, Jeremy Siegel and Michael Steinhardt. Together they plugged an ETF fund that somehow had the right mojo with respect to price earnings ratios. One would have hoped that these dim luminaries would have more dignity than to hawk such an untested concept.


Aside from the knowledge I gained of the rhythm of the markets, with the Worldwide Exchange moving to the squawk box to Morning Call, to Power lunch, to Street Signs, to Closing Bell, Kudlow and Company, then "one man, one visions, one hour." Jim Cramer with the moves in the market during each episode. These were somewhat predictably based on who was scheduled. I found that the main value I gained was realizing that the Dow Index is reported about once every five seconds, and thus, is a much better index to monitor for what just happened, and changes in microscopic inertia than the S&P Index, which is reported every 15 seconds.

Steve Leslie writes:

 I watch CNBC mostly for the entertainment value. I find much of the information they provide glorified fill between commercials although I have to admit that Liz Claman is one heck of a fill between commercials.

That said I do find value in certain aspects of the show. Most notably the premarket opening with Bob Pisani and the effervescent Rick Santelli and guests who are interviewed who actually work on the floor. Without going into detail, I have my favorites for a variety of reasons. I watch some of the aftermarket shows, Kudlow and Company, and Fast Money at 8pm. I like the format and am growing weary of O'Reilly. Yes it can happen.

CNBC dominates this space because there is really no alternative for financial news on cable TV other than Bloomberg TV, which is hard to find in some markets. I get Bloomberg on my cable provider only from 7-9AM and it is buried on the E-Channel.

For those who have a dish Bloomberg has a station available 24 hours a day, one that is much less commercialized than CNBC. My night owl friends tell me that CNBC Europe is a very good show.

Thus what is one to do for financial information when away from the office or grows tired of CNBC?

Bloomberg has a website where you can get Bloomberg TV and Bloomberg radio live on streaming media.

I find a wireless to be a marvelous alt for my home computer. I can go to any bookstore, coffee shop, library or public building or restaurant and pick up a wireless connection. Free

I trade from my PC laptop through Scottrade elite while having coffee in the morning or during meetings at lunch. I do not trade futures but Victor tells me that Laurel likes Interactive Brokers.

Sprint offers a mobile wireless now for around $40
per month down from $59.00. I can have unlimited access to the Internet through
my PC literally anywhere I go in the world.

There is also a service called go to my PC that allows a direct connection to your PC through the internet from a remote location. Thus you can connect from your laptop to your desktop or office computer.

XM Satellite and Sirius radio have simulcast of CNBC and Bloomberg for $12.95 per month. Great for commuting. Plus you get Howard Stern not Howard K. Stern (tongue in cheek)

If carrying a PC is too cumbersome or bulky, a blackberry is the weapon of choice here. One can text message and receive financial information on demand.

On the low end, cell phones now come equipped for stock quotes and other financial information on demand. Now while in transit either by plane, train, automobile, or on vacation, you can get out of the room and go fishing or sit by the pool or go to the theatres or the movies or the craps table, or watch the zanies and crazies on Duval Street in Key West and be in continuous contact with the financial markets anytime and anywhere. It is just a matter of understanding the technology. 

Henry Gifford writes:

I don't claim to know why the information on CNBC is so bad, but perhaps things are much less planned than the big players encouraging the stream of bad information.

In the field of boiler repair, there is a popular guru who knows little, and provides much misguidance. Equipment manufacturers sometimes provide good information (some people say I made a million dollars with my apparently proprietary system of reading instructions and following them), but it is rarely followed. Thus there is no pressure to improve the quality of information, which is often poor.

One conclusion that fits is to say that the industry is happy to sell boilers to replace the ones destroyed by bad practice, and the service companies are happy to do more frequent repairs. I cannot think of any counting or examining of business relationships that would prove this wrong.

But I think there is another, more correct explanation. The guru told me he cares more about magazine article deadlines than getting the articles right. The articles help sell his books and seminars, so he has an incentive to keep the articles flowing. Service companies don't see the payback in training workers who can then just quit, and don't see any reason to sell skills better than the other companies provide, as consumers can't very well have a "control" to see what would have resulted if they chose another company. In sum, the standards are low, science and counting hardly exist, and most people in the industry don't care enough to learn what they need to know.

Seen another way, picture the Chair trying to get a spot on CNBC, and using Daily Spec sales statistics as a credential. Nobody read it because it didn't tell people what they wanted to hear.

Feb

9

 Perhaps another myth:

As prices go higher, new materials are used to substitute: fiber optics; plastic for cars rather than iron and steel; etc.

Global warming (if it exists, which I doubt) seems mostly bearish for most agrarian items. This is because it will mean longer growing seasons and production in areas now too cold, hence larger supply.

Reply from George Zachar:

This should be countable. Has planted acreage spread north? Are grain shipments up on Canada's railways? Is the mix of crops changing in ways consistent with warmer climes at higher latitudes?

Two of my "you're a moron" global warming refutations are the facts that Greenland was under the plow, not ice, 1000 years ago, and there were vineyards north of London several centuries ago.

From Steve Leslie:

For those of you who are interested in global warming and the debate surrounding it, I recommend you read Michael Creighton's State of Fear.

It has plenty of suspense and intrigue as well as discussion of the merits of the scientific studies of global warming. It is very much a scientific novel. 

From Henry Gifford:

My understanding is that it is written by a fine writer who is not a scientist, and I'm not aware of any debate among scientists about what is causing global warming.

I have a copy of the Irish physisict John Tyndall's paper to The Royal Society wherin he identified CO2 as a greenhouse gas, which I understand was where the debate ended, over 150 years ago.

Stefan Jonanovich writes:

No one questions the increase in CO2 emissions as the result of human activity. What many scientists have questioned is, (1) whether CO2 is a significant contributor to the "greenhouse" mechanism as opposed to, for example, water vapor condensation triggered by increased gamma radiation, and (2) whether the recent observations of warming in some (but not all) parts of the globe have other and possibly more significant causes such as increased solar radiation.

These are reasonable questions. What is irrational is the extent to which discussion is being actively repressed even in the scientific community in the name of unanimity. What is shameful is that this global "emergency" has taken precedence over trivial matters like clean water for the million or so children who die every year of diarrhea, and cooking fuels other than wood fires for the millions of women whose lung functions are destroyed.

Jan

31

A Note from the President: 

The Chair proposes that I stick my neck out. I'm accepting only because the august company that comprises the List prevents many of us from letting it "all hang out." That's unfortunate since I believe the List has members whose forecasts might prove very insightful. However, I'm not one of them. In fact, I've been so wrong so often that one of my forecasts, if viewed as the babblings of a hoodoo, might provide a fortune to those who fade my conjectures. With that in mind, I offer an early apology for any prediction that may prove accurate.

First, in a recent post I revealed that I was over weighted in natural resources. This is an affliction that dates back many years and must be accepted with the same understanding one extends to his fellows for their inexplicable preference for blondes or redheads. So with one exception, which I'll get to a little later, we'll skip that category.

My favorite "chemical" is extremely abundant, slightly acidic, and is as essential as oxygen. It is water. I don't like it for just next year, but for the next thirty. Investor owned water stocks are few in number. Herewith are nine: AWR, WTR, CWT, CWCO, SBS, MSEX, SWWC, SZE, and UU. From here, it's a game of pick-and-choose; however, over the past year, three foreign companies (SBS, SZE, UU) have cumulatively crushed their American counterparts. However, until last year, American water companies carried the highest valuations as measured by P/E or P/B. Although the group gets little mention, American water utility stocks have outperformed other asset classes for the past 12 years. (Actually, it's been longer, but I can't find my reference.)

As most are aware, only a small percentage of the earth's water is drinkable (potable). And unlike other commodities, there is no substitute, nor is it likely more will be discovered. I have followed the desalination industry since 1974, and though much has been promised, little has been delivered (although CWCO seems to be doing very well). I believe more successes will eventually be achieved, but timing is iffy. (There's a lesson here for those who believe our energy problems will be solved shortly.)

Water infrastructure worldwide is pathetic. And it will take hundreds of billions (probably trillions) of dollars to set it right. Those who provide pipes, pumps, membranes, meters, etc. can benefit substantially. Because water is so essential to those who pump, process, and/or sell, it would seem inevitably profitable, although not necessarily. A number of years ago, I invested in one of the foreign companies listed above. They specialized in taking over municipal water works and rebuilding the systems. As required, they went in and began repairs to the system, improved efficiency, and cut down on costs (partially by eliminating public employees).

However, their investments were substantial and as agreed in the initial contracts, they sought to recover their expenses through increased charges. Every city and hamlet in this nation has a Utility Watchdog Group - their main job is to bitch about every utility increase ever put forward, regardless of its legitimacy. But, with water, the problem is especially acute. We can drive less, dress warmer indoors in winter, put up with higher indoor temperatures during the summer, shut off the gas to the decorative lighting fixtures, or move in with our in-laws. We cannot cut back much on our water consumption. So, when that price goes up, there is more than the usual complaining. If the price goes up several years in a row, the outcry cannot be ignored. As a result, the same city councils that brought in the outside company now attempt to control, freeze, or roll-back prices - even though they had no contractual power to do so.

But governments, as was just demonstrated when congress successfully demanded that legitimate contracts with the oil companies be rewritten, can do almost anything they choose. As a result, this company backed out of deals with several American cities because they could not and would not operate in the red. Running a for-profit water system in an American city should be a no-brainer money-maker - and in many cases, it is. But when the real crunch comes, when water prices, of necessity, skyrocket, it is imperative to be aware of the Cowardly American Politician who will abrogate any contract if it assures his or her continuation in office.

The group with the most to offer and with the least vulnerability to political duplicity are those companies that supply pipes, valves, pumps, meters, etc. that will become essential purchases in the immediate future. Although there are several large caps that have become involved in these areas, their exposure remains relatively small in relation to the size of their overall operation. However, there are a number of companies which could perform nicely: LAYN, NWPX, TS, GRC, LNN, HYFXF, WTS, TTI, and KELGF.

(An approach to supplying water that to date hasn't been too successful but hasn't received much attention, is the use of machines that pull potable water out of air. These machines, depending on size, can produce anywhere from two liters up per day. If the area's climate meets certain humidity minimums, the systems will work. However, I've been reluctant to even attempt a speculation as it seems something this important would have received much more coverage by this time. I'm not sure if this is a performance or a marketing issue.)

A second area that appears fruitful (but which revolts just about everyone) is coal. I doubt, despite current talk, that America will ever again go nuclear. (And even if I'm proven wrong tomorrow, the first new plant wouldn't be up and running until 2015). And the movers and shakers (that phrase, by the way, is from a very nice poem, We Are the Music Makers) have determined that we will cut back on gasoline (i.e, oil) consumption. The cuts envisioned are Lilliputian and one of the proposed substitutes, corn-based ethanol, is an excellent example of why a government should never be allowed to determine efficiency.

The recent news stories on the escalating price of tacos and the Mexican government's reaction to it, is the first bell in the death knell of corn-based ethanol. The next bell will be an American one when prices of pork and chicken begin to rise because we've determined it's more important to feed our cars than the livestock our consumers count on for protein.

Yes, perhaps we can expand corn growing acreage (at the expense of soy beans, but only with the use of more fertilizers, pesticides, and herbicides) and satisfy both demands - at least until the weather, a capricious demon, decides otherwise. Additionally, the very best estimate I've seen to date on daily ethanol production (assuming the current 116 plants and the 79 under construction are all up and running) totals 718,000 barrels. That's 3.5% of our daily requirement. If we all decided to never exceed 60 mph, we would save that much. (Interesting fact: the amount of grain it takes to produce 25 gallons of gas could feed one person for an entire year.)

It doesn't appear that either the Congress or the states are in the mood to approve drilling in the Rockies, in Alaska, or offshore in any of our sanctified coastlines. Russia and China are moving quickly and decisively in striking long-term deals with foreign oil producers. India is beginning to search for deals. Europe appears content to whine over Putin's insensitivity while hoping his tenure is followed by a kinder, gentler former KGB operative. Our oil companies aren't doing much more than being kicked out of Russia and Venezuela.

But we still will need a fuel and we will need it in abundance and we will need it from a dependable source. Coal is the only alternative. And it need not be the dirty, filthy stuff that used to be poured down the basement shoot when I was a kid. Germany developed the Fischer-Tropsch method for synthesizing a hydrocarbon like coal into a much cleaner burning liquid. We have several companies (mostly small ones, but I understand GE is testing the waters) who are currently using the process with our largest coal producers.

The process works. The question to be answered is at what level (of acceptable carbon output) will the bar be set. There exist influential groups who feel no level (of coal emissions) is acceptable. I doubt that they'll prevail. But should they, you can be sure that when Americans begin shivering too much in winter and sweating too much in summer, they'll be rolled flatter than a nickel beer. As with the Fischer-Tropsch companies, I'm not going to name any candidates as they're not that numerous and my omissions would be indicative of my holdings. (By the way, I do not own any of those stocks whose symbols I have listed.)

Those are my two primary targets. Water shouldn't be a surprise; it's been a great idea for a long time. Coal is something else; to some it may seem like buying into pornography. For those, I suggest searching the geothermal field, though initially expensive, the systems work (in both summer and winter), and can be installed almost anyplace where several deep holes can be drilled.

I became president of the old duck hunters courtesy of Gordon MacQuarie's great stories. It's appropriate then that I end with a Macquarie story (notice the difference in spelling.) My son will be 42 next month and has been a confirmed bachelor. Just two weekends ago I received an email from him (he's lived in Japan for six years) announcing his marriage this coming July in Honolulu. Now I felt I was pretty well set in making whatever minor financial arrangements I could for my children and theirs. (Lord knows we're leaving them with enough debts.) This adds a new dimension and one that requires real long-term thinking.

For those in the same boat, check out MIC, The Macquarie Infrastructure Fund (there are a group of Macquarie Funds and you may find one more appropriate). This fund has been buying up (or getting long-term - 75 year - leases) on tollroads, airport parking lots, commercial heating and cooling outfits, and energy service providers. If it's something that's an absolute public necessity, Macquarie owns or holds a long term lease on it. It pays a great dividend, but I'm told, reading their financial statement, it will give you the yips.

I now yield the field for at least a year.

The President further adds:

Scott asks a good question and, frankly, I don't know how to answer it. But I believe we have reached a point where we have to admit that governments and their offspring are poorly run. And though the threat of government interference is always real, the current state of government, especially at the state level, could actually prove beneficial.

For example, Macquarie and another outfit leased the Indiana Skyway for 75 years for $3.85 billion. It's estimated the companies will recoup their investment in 17 years and make an additional $21 billion over the remaining 58 years.

There has been talk of Daley also leasing the Illinois Tollways. Two days ago, Illinois announced it was leasing its lottery for $10 billion. These will be huge income generators for years. Likewise, Tennessee and several other states sold their future cash flow from the Tobacco settlement for discounted sums so that they could balance their annual budgets for two years. The buyers will reap nice returns for years.

Many states, and Illinois is one of the biggest offenders, have contributed little or nothing to their states' employee retirement funds over the past six years. Their only outs are raising income taxes (not going to happen) or selling off their hugest cash generating properties - for lengthy terms and at substantial discounts.

Our state governments, like our federal government, have been badly run, and finding additional revenue streams is getting harder and harder. In each case, though, the lessee has made sure the state has kept a financial interest in the asset; this seems a smart move as it might discourage the governments from taking draconian actions in moments of remorse.

For selected firms, then, governments may be providing great investment opportunities. We may be in the early days of an entirely new asset class; especially for those with long term investment horizons.

Jaime Klein adds: 

Currently, the only cost effective technology to extract drinking water from air humidity is cloud seeding. It is routinely done in Israel (and other places) and causes about a 10% increase in rainfall (amounting to about 800 million cubic meters per year). Since only about 15% of the rainfall is actually used (in agricultural irrigation, tapwater, etc.) artificial cloud seeding produces some 120 million cubic meters/year.

As Henry's insightful note shows, the production of fresh water is a question of energy. All the oceans are full of water so there is no scarcity of raw material. And all the water is being recycled in nature so it will never "end." In Israel, we are producing 200 million cubic meters/year of fresh water by desalination for an average cost of 0.65 U.S. dollar per cubic meter (the consumer pays an average of 1 $US/cubic meter). The desalination industry was established by the State and operates under 20 year-long contracts, selling all its production to the State at a fixed price. There are no free markets in water, not here nor everywhere, since conduction and distribution is a natural monopoly.

In my opinion (shared by Treasury's wonderkids), Israel doesn't need that expensive water, and the desalination industry was established in a moment of national panic caused by a two-year long drought.

By the way, water demand can easily be reduced by increasing its price. The curve is quite inelastic since water costs so little. In fact, even in Israel where domestic water is very expensive, the water company's bill is less than 1% household income. Wastewater removal and treatment may cost an additional 1%. I don't think anybody will make fast profits in the water industry in the coming years.

Henry Gifford offers: 

The question was raised about how much energy it takes to run a machine that takes water out of the air. I will show some counting on the question, and let others reach their own conclusions about why they are not popular.

Starting with the same 25 gallons of ethanol, which was described as being made from a year's worth of food:

84,100 BTU/Gal x 25 - 2,102,500 BTU / 3.41 = 616,568 WattHours of energy in the ethanol

Assuming current USA electricity grid efficiency of 33% (Source: Electric Power Research Institute), that can be converted to 203,467 WattHours of electricity.

An off-the-shelf dehumidifier (Grainger part # 5BB55, info below) takes 30 pints of water out of air per day, and uses (115 Volts x 5.3 Amps) 609 Watts to run. Therefore the 25 gallons of ethanol could perhaps run it for (203,467/609) 334 hours, yielding (334 x 30) 10,000 gallons of water. Probably the machine is rated under ideal conditions (high humidity, low temperature), and therefore the machine can only produce a small fraction of that under more realistic conditions - 500 or 1,000 gallons of water from 25 gallons of ethanol?

A test could be done by putting a bucket under the drip from a window air conditioner or a dehumidifier, and measuring how long it takes to fill the bucket, and then comparing how much electricity the machine uses.

Dehumidifier, 30 Pints Residential Dehumidifier, Capacity 30 Pints in 24 Hours, 115 Volts, 60 Hz, 5.3 Amps, Fan CFM 181, Humidity Range 20 to 80 % RH, Ambient Temp Range 64 to 95, Fan Speeds 1, Bucket Capacity 17.2 Pt, Height 22 7/8 In, Width 15 3/8 In, Depth 12 2/3 In, Impact Resistant Thermoplastic Cabinet, Color White, Includes Four Casters, Removable Front-Loaded Bucket, Hose Connection For Continuous Drain Operation, Filter

Henry Gifford further adds:

I understand that there are no free markets in water here, but disagree that the reason is that conduction and distribution are natural monopolies. There is no free market for corn, apartments, car rentals, health insurance, or many other things here for which there are multiple players competing for the same customer.

New York City's water is of higher quality than the bottled water in most places (usually just municipal water run through a filter), yet it "sells" for only $1.25/cubic meter, which hardly covers the cost of repairing the pipes. Indeed it is still "too cheap to the meter" - many customers still have no meters. As said below, use can hardly go down when the price is too low.

Catching and storing and cleaning and drinking/using rainwater runoff from roofs has been routine in the Caribbean for generations, and is increasingly done in the U.S. Southwest, and would be more popular if subsidized water and electricity (for pumping) were not available.

Jaime Klein responds:

(1) The domiciliary water supply market is a natural monopoly not because of regulation or subsidies, but because the customer has no alternative supplier. All attempts to introduce competition have failed. Even so, the price is dirt cheap.

(2) Rainfall catching water supply systems are fantastically expensive and dangerous to your health. If the price paid for one cubic meter of drinking water from a municipal system is, say, one $US, then the cost of the equipment to catch rainfall, to store, to purify and to pump it (investment + M&O) is, comparatively, astronomical, and averages $15 per cubic meter. As a conversation piece or environmental toy, it may be worth it, but please don't drink the water. Rainwater is not pure, it carries atmospheric particles and poisonous gases. Water from the first rains of the season are highly contaminated and toxic. Even urban tree foliage suffers. The water has to be stored, which is another potential source of contamination. The water has to be purified, possibly by addition of a chemical or by reverse osmosis. It has to be tested before consumption. This is a highly professional area, certainly not for amateurs.

In Israel, the Ministry of Health discourages home rainfall catchment systems, and in practice forbids it. There are strict water testing programs (every two weeks, samples are to be taken by licensed samplers and sent to licensed laboratories) and the water has to meet quality standards (zero coli count, pH, etc.). None of the traditional rainfall catchment systems (and there are many in Israel) are able to supply water of drinking quality and are de facto forbidden. It is not that the Ministry has inspectors searching for home systems to close them down, but no permits have ever been granted.

Henry Gifford comments: 

Imagine you were running a government in a desert area as described below. Thousands of your subjects would know the history of the people who lived for thousands of years in houses without modern heating or cooling and who used thermal mass to even out the diurnal heating/cooling load. Some would know that with modern windows and a few centimeters of foam on the outside of the thermal mass, modern standards of comfort can be achieved easily. Abundant solar energy could make hot water for showering and electricity. This would leave people able to live entirely "off the grid" except for one thing: safe drinking water.

Having people depend on a centralized water system would be good for the government, especially in an area where governments have a history of organizing wars for control of land with abundant water resources. Therefore I find it unsurprising that a government in an arid area tells people rainwater is unhealthy, and cannot be made healthy. Governments in other areas, such as the Caribbean and Texas, tell people the opposite.

Henry Gifford adds:

 I apologize sincerely about your "concerns for Israel", which you describe as the "mass immigration" of "potential husbands" to Wall Street here in New York. The street is only a few blocks long, yet is big enough to drain the pool of potential husbands from many countries. A proportionally sized financial center in Israel would be far less than one block long, which might leave some of your four beautiful, talented daughters in the same predicament as many beautiful, talented US women: stuck choosing from millions of single men who do not work on Wall Street.

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