vinod1

LOL ShahKhezri, How are they special? Any insight you can share? Thanks Vinod

Here are two books 1. Bull! A History of the Boom, 1982-1999 by Maggie Mahar - Also recommended by Buffett 2. Origins of the Crash: The Great Bubble and Its Undoing by Roger Lowenstein Vinod

Looking at this particular point in time, I like FAIRX allocation with about 50% in AIG/BAC. I would expect FAAFX to have better returns over the long term, for reasons already mentioned by others. I split the investment equally between them. Vinod

Ok Eric, this might make you happy. http://www.businessinsider.com/goldman-the-economic-crisis-ends-in-2013-2012-12 Vinod

Feeding the Dragon - GMO paper on Chinese credit bubble. https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIA6KcUdqlSIwIXyKFLDu0ahgi%2fVwwPhMBjQBiRm%2bRLnDmOmauuxY3ieIGb5rFygoEWoFXDEs8Gu%2bAyctYJBUNhPmb9KxTYFrE8%3d From a valuation perspective, Chinese equities do not, at first glance, look to be a likely candidate for trouble. The PE ratios are either 12 or 15 times on MSCI China, depending on whether you include financials or not, and the market has underperformed MSCI Emerging by about 10% over the last three years (ending December 31, 2012). Neither of these characteristics screams “bubble.” And yet, China has been a source of worry for us over the past three years and continues to be one, affecting not merely our behavior with regards to stocks domiciled in China but the entire emerging world, as well as some specific developed market stocks, which we believe are particularly vulnerable should things in China go down the road we fear it might. Vinod

giofranchi 1. To your point about comparing to Weimar Republic in Germany or Japan during the last 20 years. I do not think US position now can be compared to Weimar Republic in Germany of 1920's. The magnitude of the monetary increase is several orders of magnitude higher in Germany. When we are talking about inflation in US we are talking about 3%, 4% or 5% or even high single digits. Compared to US GDP, all the US monetary increase is still a smallish number compared to the increases required for hyperinflation. The situation US is in could be compared to either 1929 GD in US or Japan in the last 20 years. As Richard Koo points out these are both cases of a "Balance Sheet Recession". Here a lot of private sector balance sheets needs to be repaired. The defining characteristic of this case is that private sector moves away from their usual profit maximization to debt minimization. Japan's stock market is down 75% from its peak, whiles its real estate is down 70% from its peak. The fact that they have been able to avoid a great depression type economic contraction, I think they did pretty good. Given that US has been much more aggressive I think US would do much better compared to Japan. Either way there is a price to be paid and it might end up as either sub par economic growth for a while, higher inflation, more economic uncertanity, etc. 2. To you point about "once you go into debt you are screwed". I agree and think most of the policy makers realize this as well but they cannot come out and say that. It is now a matter of coming out of this with the as little collateral damage as possible. 3. To your point about investment implications. I have no idea of how this all plays out, only thing I know is that risk is much much higher than normal. The prices of overall market in general does not seem to reflect this risk. So I have repositioned my portfolio for the last two years with this in mind. This means several things: - Portfolio with much higher cash allocation. - Strict selling criteria. Selling any business which exceeds 80% of IV unless there is a clear and imminent catalyst. - Portfolio concentrated on extreme value leveraged via LEAPS or Warrants. So I can have like a 80% nominal portfolio exposure while having very roughly around 70% cash. Vinod

giofranchi, Some info on the liquidationist school: http://www.mannmuseum.com/american-policies-during-the-great-depression/2/ Contemplating the wreck of his country's economy and his own political career, Herbert Hoover wrote bitterly in retrospect about those in his administration who had advised inaction during the downslide: The 'leave-it-alone liquidationists' headed by Secretary of the Treasury Mellon felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: 'Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate'. He held that even panic was not altogether a bad thing. He said: 'It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people' But Hoover had been one of the most enthusiastic proponents of "liquidationism" during the Great Depression. And the unwillingness to use policy to prop up the economy during the slide into the Depression was backed by a large chorus, and approved by the most eminent economists. For example, from Harvard Joseph Schumpeter argued that there was a "presumption against remedial measures which work through money and credit. Policies of this class are particularly apt to produce additional trouble for the future." From Schumpeter's perspective, "depressions are not simply evils, which we might attempt to suppress, but forms of something which has to be done, namely, adjustment to change." This socially productive function of depressions creates "the chief difficulty" faced by economic policy makers. For "most of what would be effective in remedying a depression would be equally effective in preventing this adjustment." From London, Friedrich Hayek found it: ...still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed. The only way permanently to 'mobilize' all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production... Hayek and company believed that enterprises are gambles which sometimes fail: a future comes to pass in which certain investments should not have been made. The best that can be done in such circumstances is to shut down those production processes that turned out to have been based on assumptions about future demands that did not come to pass. The liquidation of such investments and businesses releases factors of production from unprofitable uses; they can then be redeployed in other sectors of the technologically dynamic economy. Without the initial liquidation the redeployment cannot take place. And, said Hayek, depressions are this process of liquidation and preparation for the redeployment of resources. As Schumpeter put it, policy does not allow a choice between depression and no depression, but between depression now and a worse depression later: "inflation pushed far enough [would] undoubtedly turn depression into the sham prosperity so familiar from European postwar experience, [and]... would, in the end, lead to a collapse worse than the one it was called in to remedy." For "recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another [worse] crisis ahead" This doctrine--that in the long run the Great Depression would turn out to have been "good medicine" for the economy, and that proponents of stimulative policies were shortsighted enemies of the public welfare--drew anguished cries of dissent from those less hindered by their theoretical blinders. British economist Ralph Hawtrey scorned those who, like Robbins and Hayek, wrote at the nadir of the Great Depression that the greatest danger the economy faced was inflation. It was, Hawtrey said, the equivalent of "Crying, 'Fire! Fire!' in Noah's flood." Vinod

That’s simple. To cure the debt problem with more debt… I don’t understand how it should work: so, either I am dumb, or it is too complicated. Probably, the former. :( giofranchi No, no, no. I think you choose not to understand since it does not conform to your view of the world. :) I do that all the time. On this particular issue, I have changed my own opinion on this a couple of years back. I would lay out my understanding briefly and you can point out where you disagree. I am talking just about US here. Consumers took out more debt than they can service over the past several years for a variety of reasons (housing bubble, easy loans, falling interest rates, central bank encouragement, stagnating wages, etc.). The financial crisis of 2008-2009 with falling asset prices, unemployment, etc made debt servicing more difficult for consumers who have logically pulled back from spending and started saving, thus beginning the process of reducing debt levels. The reduced spending by consumers creates headwinds for the economy resulting in sub par growth and also reduces government revenues. The government at this time can choose not to do much and just let nature take its course and let those who have recklessly borrowed more money suffer. The result would be that economy would take a much sharper downturn, housing and other assets deflate, bad banks get wiped out, lenders take haircuts on the money lent. Once this process works through, economy regains strength. The problem with this approach is that it would cause tremendous suffering. We are probably talking about GDP declines of peak to trough of something like 10-15%, unemployment shooting to 20%, etc. Jim Grant, Hussman, Rodriguez and many others think this should be the process that should be followed. There is a moral component to this line of reasoning. This approach has been argued as the quicker way to resolve the crisis, but we cannot be sure about that. We have tried this in 1929 with disastrous results. The other approach has been for Government to step in and try to take debt for a while as the consumer slowly deleverages. The Government does take on debt so Government spending would try to offset some of the reduction in spending by consumers. Monetary policy is kept as loose as possible via various mechanisms to allow borrowers to deleverage via lower interest rates or via higher inflation. We do know this is not sustainable for ever and this is not without risks. But this would be the best of the bad options. Vinod

No one is saying there is a magical solution. That is a strawman argument. Monetary policy is not the right tool to fight a liquidity trap, but Fed is doing what it can with the tools it has. From "End the Depression Now" Can Debt Cure a Problem Created by Debt? One of the common arguments against fiscal policy in the current situation—one that sounds sensible—runs like this: “You yourself say that this crisis is the result of too much debt. Now you’re saying that the answer involves running up even more debt. That can’t possibly make sense.” Actually, it does. But to explain why will take both some careful thinking and a look at the historical record. It’s true that people like me believe that the depression we’re in was in large part caused by the buildup of household debt, which set the stage for a Minksy moment in which highly indebted households were forced to slash their spending. How, then, can even more debt be part of the appropriate policy response? The key point is that this argument against deficit spending assumes, implicitly, that debt is debt—that it doesn’t matter who owes the money. Yet that can’t be right; if it were, we wouldn’t have a problem in the first place. After all, to a first approximation debt is money we owe to ourselves; yes, the United States has debt to China and other countries, but as we saw in chapter 3, our net debt to foreigners is relatively small and not at the heart of the problem. Ignoring the foreign component, or looking at the world as a whole, we see that the overall level of debt makes no difference to aggregate net worth—one person’s liability is another person’s asset. It follows that the level of debt matters only if the distribution of net worth matters, if highly indebted players face different constraints from players with low debt. And this means that all debt isn’t created equal, which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past. Think of it this way: when debt is rising, it’s not the economy as a whole borrowing more money. It is, rather, a case of less patient people —people who for whatever reason want to spend sooner rather than later—borrowing from more patient people. The main limit on this kind of borrowing is the concern of those patient lenders about whether they will be repaid, which sets some kind of ceiling on each individual’s ability to borrow. What happened in 2008 was a sudden downward revision of those ceilings. This downward revision has forced the debtors to pay down their debt, rapidly, which means spending much less. And the problem is that the creditors don’t face any equivalent incentive to spend more. Low interest rates help, but because of the severity of the “deleveraging shock,” even a zero interest rate isn’t low enough to get them to fill the hole left by the collapse in debtors’ demand. The result isn’t just a depressed economy: low incomes and low inflation (or even deflation) make it that much harder for the debtors to pay down their debt. What can be done? One answer is to find some way to reduce the real value of the debt. Debt relief could do this; so could inflation, if you can get it, which would do two things: it would make it possible to have a negative real interest rate, and it would in itself erode the outstanding debt. Yes, that would in a way be rewarding debtors for their past excesses, but economics is not a morality play. I’ll have more to say about inflation in the next chapter. Just to go back for a moment to my point that debt is not all the same: yes, debt relief would reduce the assets of the creditors at the same time, and by the same amount, as it reduced the liabilities of the debtors. But the debtors are being forced to cut spending, while the creditors aren’t, so this is a net positive for economy wide spending. But what if neither inflation nor sufficient debt relief can, or at any rate will, be delivered? Well, suppose a third party can come in: the government. Suppose that it can borrow for a while, using the borrowed money to buy useful things like rail tunnels under the Hudson, or pay schoolteacher salaries. The true social cost of these things will be very low, because the government will be employing resources that would otherwise be unemployed. And it also makes it easier for the debtors to pay down their debt; if the government maintains its spending long enough, it can bring debtors to the point where they’re no longer being forced into emergency debt reduction and where further deficit spending is no longer required to achieve full employment. Yes, private debt will in part have been replaced by public debt, but the point is that debt will have been shifted away from the players whose debt is doing the economic damage, so that the economy’s problems will have been reduced even if the overall level of debt hasn’t fallen. The bottom line, then, is that the plausible-sounding argument that debt can’t cure debt is just wrong. On the contrary, it can—and the alternative is a prolonged period of economic weakness that actually makes the debt problem harder to resolve. I have been pissed off with Krugman's columns in NYT for various reasons (too partisan) but his book is a gem. Vinod

If you are going to index then at the very least you need to keep up to date on GMO's asset class forecasts. If you are going to be putting small amounts of money over very long periods of time, then this might not be needed, but if you are going to put say significant amounts then you need to pay attention to valuation. Other choice is go with DFA Funds and focus on value indexes. They have pretty good funds although for the wrong reasons (Fama French nonsense...). Vinod

Kraven - I like your analogy so much that I copied it into my notes. Thanks Vinod

Not really. I think most hedge funds operate to shoot the lights out, leveraging to the hilt due to the incentive structure of 2/20. If they blow up, they start anew. So in any period where a black swan type event shows up, hedge funds under perform. On the other hand when everything goes well they outperform. This is just another version of "Dunn's law of mutual fund performance" applied to hedge funds. Dunn's Law states that “When an asset class does relatively well, an index fund in the asset class does even better. In contrast, when an asset class does poorly, the active managers do better in that asset class.” http://www.efficientfrontier.com/ef/400/dlr.htm Vinod

None in aggregate and in the long run - notable subgroups who I think are the exception are proprietary traders with benefit of front running/insider trading and Grahamites. Index investors get the market return, all others get market return less fund expenses (transaction costs, fund fees, taxes, etc). So the total return for all active investors must by definition be less than the market. Vinod

Over the past 5 years: WFC, BNI, JNJ, USG, KFT, WMT, arguably even BAC at its lows. :) Vinod Yeah, but were you able to buy those before he did? Point is, he's telling the world, "I'm going to buy this stock at this price because its really really cheap", he didn't do that with BNI or JNJ or WFC. He did tell the world that those stocks are cheap by buying aggressively and these stocks are available at lower prices after these purchases were reported. Vinod

Over the past 5 years: WFC, BNI, JNJ, USG, KFT, WMT, arguably even BAC at its lows. :) Vinod

Why do you think we should not mix morality with good economic decision? Why inflict suffering on the rest of the population via economic turmoil by bankrupting the companies, etc. Even though the policies bailout some of the people who took the risks, we should not let it implement policies that would benefit the overall economy. We have been down this road before in 1930's. What you are proposing is what Herbert Hoover has tried with disastrous results. http://www.mannmuseum.com/american-policies-during-the-great-depression/2/ Contemplating the wreck of his country's economy and his own political career, Herbert Hoover wrote bitterly in retrospect about those in his administration who had advised inaction during the downslide: The 'leave-it-alone liquidationists' headed by Secretary of the Treasury Mellon felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: 'Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate'. He held that even panic was not altogether a bad thing. He said: 'It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people' As to Japan, I agree it is not sustainable. Just saying all the "Doom and Gloom" about Japan has been 100% wrong for the past 12 years. It is likely to be wrong going forward as well as Japan would find a way to muddle through. If I had made a prediction and been wrong about something for 12 years, I would reconsider the thesis. You need to be able to put some realistic time frame and say if you was not proven right by that time, you am probably wrong. To me the Doom and Gloom thesis about Japan fits the bill. Your statements contradict themselves: “Fed can buy as many bonds as it wants.” And “the only way inflation is going up is if economy is booming”. That’s not possible in my opinion; monetization of the debt is clearly inflationary in the long term. We live on earth and there is gravity. Again I grew up in France in the 80s and I’ve seen inflation. Believe me it was not due to a booming economy… Inflation has to come from two sources 1. Cost push - via increase in input costs typically raw materials. Since services are taking up a larger share of the GDP, any such cost push inflation is likely to be modest. It might be a tad high but that would be within acceptable range. 2. Demand push - Inflation should come only when consumers are able to spend more money on goods/services. Unless government directly stuffs everyone's pocket directly with currency, literally throwing money from Helicopters, the only way consumers would be in this position is when economy improves and unemployment drops thus putting pressure on wages. In the 1970s it is a combination of cost push (oil) and wage contracts/plensions that had built in inflation adjustments. Both of these risks are dramatically lower now - commodities make smaller percent of GDP; Lower percentage of workforce under unions, lower percentage of workforce having any built in wage inflation clauses, lower number of people with pensions that have built in wage increases. All this makes inflation less likely. Fed is going to suck up liquidity when it needs to i.e. when economy starts growing rapidly. You are basically assuming that just because debt if monetized it automatically leads to inflation. It would not. Its effect has to flow through the two mechanisms above. Fed would act when needed so it would not lead to higher inflation. Vinod

Thanks! I would contact the broker. Vinod

Put a sell order at $0.01 and ask (pay) a friend to buy them. Thanks! I had that thought but not sure if that would go through. I have seen the options trade at $0.02 while mine is not getting executed. Vinod

The shareholders of the institutions have suffered. It is only the management that has not suffered and I do not see how punishing the companies further would teach the management any lessons. Management has made the money and even if they lose their jobs it is not really a big deal for them. In contrast the shareholders and the vast majority of the people via their pensions, 401k, etc would suffer if Government did not help save many of the companies. Take AIG, their shareholders have suffered, the managers have been fired (but they did keep all their money), so what would be the point of bankrupting it? To teach future shareholders? Government has to act for the greater good and if it means some have not been punished so be it. There are other ways to deal with moral hazard. I do not think we should mix "morality" with good economic policy. Iceland is a tiny country and I do not think those lessons can be applied to US. Their currency collapsed by 80% which would give a boost to a small economy like Iceland without impacting other countries (since it constitutes only a very small part of the trade for larger countries). It looks like they have written off the debt of consumers (moral hazard, immoral, helping out the incompetent - all that you seem to oppose). I have been hearing about the day of reckoning since 2001. I think they would manage just fine as US has done in 2009-2009. A little hiccup and business as usual. Again they want the Yen to collapse. It is not going to happen. Fed can buy as many bonds as it wants. Spain and Greece cannot. The only way interest rates are going to raise is if inflation raises. Cost push inflation (via a commodity inflation) is unlikely but even if it happens it would not be all that large as they constitute much smaller % of GDP now. Again to my point, the only way inflation is going up is if economy is booming. So we are not going to see pressure on the bond market until the economy booms. Vinod

I have a few HP options with a strike price ($30) way above the current price and expiring in Jan 2013. I have put a market sell for the last 2 weeks on IB but it is not getting executed. I would sell it for $0 or even even a negative price if I can to take advantage of the tax loss but IB does not allow me put any number below $0.01 if I do a limit order. Does anyone know of a way to get rid of these options in a way I can claim tax loss? This is a minor amount so I can let it expire and take the tax loss for 2013 but just wanted to see if there is any other way. Thanks Vinod

Is it really that tough for a chinese firm to break into this say by buying Toshiba's HDD unit? You are right about this being yesterday's technology and it turning off potential competitors. But if they keep earning 30-40% ROE's I wonder how long it can continue without some competition. Vinod

I thought so to and have heard a lot of people say that. However, technology/patents, reliability (we're talking backing up your data here!), vertical integration and OEM relationships create more of a barrier to entry than people give the companies credit for. Following on that an related to your ROE question. That competitive position gives them pricing power. Maybe it is really as simple as that. Everyone seems to be looking for something more complicated than that, but maybe it is just as simple as...they have pricing power and the proof is right there infront of us. You are probably right about the patents and OEM relationships creating some barrier to entry but they seem very similar to semiconductor memory makers where they do not have good profitability. Thanks Vinod

I understand where you are coming from since this is pretty much what I used to believe. I have changed my opinion since after reading Richard Koo's and Bernanke's writings. 1. I agree monetary easing is not the solution. The main solution would be via fiscal policy. But given the deadlock on fiscal policy, Fed is doing its bit, which is through monetary policy and they are keeping rates low when unemployment is high and inflation is low. Are they supposed to raise rates when both unemployment is high and inflation is low? QE is only an extension of this logic and it makes sense to me. I do not understand how increasing interest rates would clense the system? How does that work? 2. Japan's stock market is down 75%, residential real estate is down 70% and commercial real estate is down 85%. I would think that if this happened in any country there would be a depression with very high employment (say over 20%). The fact that Japan has been able to keep its nominal GDP pretty stable and unemployment pretty low (less than 5%) seem to be an outstanding achievement. I think they did an awesome job. 3. Do not disagree that continued low interest rate in mid 2000 contributed to the housing bubble. Fed did mess up. 4. I do not understand how the "bond market is going to revolt". What would cause it to revolt? The only way is via inflation, if not Fed would be buying as much debt as needed (Monetization basically). Barring a cost push inflation, inflation would only increase if GDP is booming. That would not be too bad. As to the value of the dollar being questioned. That is part of the plan. Vinod

I do not see major barriers to entry in this industry. These guys are earning very high ROA (>15%) and ROE (>25%) even after you add back the writeoffs of goodwill. What could be the moat that is enabling these companies to earn such high ROA and ROE? If these rates of return could be sustained I would think many other competitors would jump into this. The main barrier could ironically be due to the growth of SSD and expectation that HDD would decline. This would prevent competitors from making major investments in this industry and thus leave the field open to WDC/STX to milk it as long as they can. Now that the industry has consolidated, assuming both of these guys act rationally (likely since they have seen the benefits of it) they might very well continue to earn high rates. Any idea of why they have been able to maintain such high ROA/ROE in the past (2000-2007)? Are there some real barriers to entry? Thanks Vinod

I do not think 10x optimistically rules out BAC over ten years, but you are right that 40x would seem to discredit the idea. Looks like I should bring myself back up-to-speed on CHK. Yeah I think considering he gave it scale of 10-40, I think it rules out BAC. I agree its possible BAC could be a 10 bagger over the next 10 years or longer, but no way 40x. CHK is at an 11B market cap today, a 40 bagger would mean if you owned the whole company and kept all the dividends that your stake would be worth around 440B divs included. It seems hard to believe that even between dividends and spin offs that CHK could generate that much value and the next XOM. So I think I retract my "its got to be CHK". Although I am long CHK so I would be more than happy for this play out :) I don't follow ZINC but is much smaller and appears to be involved in nickel and recycling. Anyone know more about ZINC? I think the assumption is there would be a buyback of significant number of shares. With a 50% buyback, I think CHK even at 40x might be within the realm of possibility. Vinod