FW: JAMES MONTIER

A fantastic interview with pearls of wisdom.

Dear Readers,
I’m especially happy to post an interview with my friend James Montier. I’ve often admired James and count myself  fortunate to have learned a great deal from him.Enjoy!
Best,
Miguel
James Montier Background (via GMO):
Mr. Montier is a member of GMO’s asset allocation team. Prior to joining GMO in 2009, he was co-head of Global Strategy at Société Générale. Mr. Montier is the author of several books including Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance; Value Investing: Tools and Techniques for Intelligent Investment; and The Little Book of Behavioural Investing. Mr. Montier is a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc. in Economics from Warwick University.

*image via Amazon

Interview is copyright of Miguel Barbosa & James Montier 2010

Part 1: Interview with James Montier: Value Investing – Tools & Techniques for Intelligent Investing
Miguel: James it’s a great pleasure to have you here. Thank you for taking the time to answer my questions and tell us about your latest book.
Miguel: Your book is called Value Investing – Tools & Techniques for Intelligent Investing. Luckily for us it is an annotated collection of your best pieces for Soc Gen. That said I’d like to ask you some questions to better introduce your writing to our readers.
Miguel: Let’s talk about the concept of seductive details…can you give us an example of how investors are trapped by irrelevant information?
James Montier: The sheer amount of irrelevant information faced by investors is truly staggering. Today we find ourselves captives of the information age, anything you could possibly need to know seems to appear at the touch of keypad. However, rarely, if ever, do we stop and ask ourselves exactly what we need to know in order to make a good decision.
Seductive details are the kind of information that seems important, but really isn’t. Let me give you an example. Today investors are surrounded by analysts who are experts in their fields. I once worked with an IT analyst who could take a PC apart in front of you, and tell you what every little bit did, fascinating stuff to be sure, but did it help make better investment decisions, clearly not. Did the analyst know anything at all about valuing a company or a stock, I’m afraid not. Yet he was immensely popular because he provided seductive details.
Miguel: Interestingly you connect the dangers of irrelevant information to modern risk management. I’m referring to your comments on Value at Risk – “VAR is fundamentally flawed after all it cuts off the very it of the distribution that we are interested in: the tails! This is akin to buying a car with an airbag that is guaranteed to work unless you have a crash…” Can you tell us more?
James Montier: Sure. Modern risk management is a farce; it is pseudoscience of the worst kind. The idea that the risk of an investment, or indeed, a portfolio of investments can be reduced to a single number is utter madness. In essence, the problem with risk management is that is assumes that volatility equals risk. Nothing could be further from the truth. Volatility creates opportunity. For instance, was the stock market more risky in 2007 or 2009? According to views of risk managers, 2007 was the less risky year, it had low volatility, which they happily fed into their risk models and concluded (falsely) that the world was a safe place to take risk. In contrast, these very same risk managers were staying that the world was exceptionally risky in 2009, and that one should be cutting back on risk. This is, of course, the complete opposite to what one should have been doing. In 2007, the evidence of a housing/credit bubble was plain to see, this suggested risk, valuations were high, it was time to scale back exposure. In 2009, bargains abounded, this was the perfect time to take ‘risk’ on, not to run away. Risk managers are the sorts of fellows that lend out umbrellas on fine days, and ask for them back when it starts to rain.
Miguel: I’d like to transition to another concept, “narrow framing – our habit of not seeing through the way in which information is presented to us”. Give us an example of how this harms investors.
James Montier: The best example of narrow framing that I can think of is the use of pro forma earnings. Think about what pro forma earnings mean….Essentially this is a company turning up and saying, hello I’m lying to you, these are the earnings I didn’t make, but I’d be jolly grateful if we could all just pretend I did. So what do our legions of analysts do, they don’t question the use of these made up numbers, they go and right up the press release, like some overpaid PR machine. Investors regularly fail to look through the way information is presented to them in this fashion.
Miguel: You talk about the benefits of reverse engineering DCF models – as a check on implied growth rates. Run us through the basic steps of a reverse dcf?
James Montier: In theory DCF is a great way of valuing a company (in fact, the only way). However, it’s implementation is riddled with pitfalls. With enough creativity a DCF can turn out any answer you like. So rather than try and combat this, I prefer to use reverse dcf. This effectively takes the market price, and backs out the growth that would be required to justify the current price. I can then compare that implied growth against a historical distribution of all company growth rates over time and see whether there is any chance of that growth actually being achieved.
In terms of the mechanics, these things can be a simple or a complex as you like. I tend to use a three stage model, I use the analyst inputs for the first three years, and a trend GDP related growth rate for the terminal years, and then imply what the market implies for the middle period of growth.
For instance, at the moment the mining sector implies 12% growth p.a. each and every year for the next two decades! That is a cyclical sector with an implied growth rate double a generous estimate of nominal GDP growth. Cyclicals masquerading as growth stocks rarely end well for investors.
Miguel: Tell us about the price = quality heuristic? Why do investors overpay for beauty and underpay for toads…after all they are one step away from becoming princes are they not? This heuristic complements the Anginer et all study where ugly defendants are more likely to be found guilty and receive longer sentences than attractive defendants.
James Montier: We humans have a bizarre bias against a bargain. For instance, my friend Dan Airely has done some great experiments in this field showing some pretty odd findings. Imagine you taste two glasses of wine one you are told comes from a $10 bottle, the other comes from a $90 bottle. You will almost certainly say that the $90 wine tastes much better. The only snag is that the two wines are exactly the same. So never come to dinner at my house, because I’ll give $10 wine, and tell you it costs $90!
The same thing happens with pain killers. It is why branded pain killers exist alongside generic equivalents. They both have exactly the same active ingredient, but people report the branded version works better.
I suspect that something similar happens with stocks. Stocks are the one thing we don’t like to see on sale. So a ‘cheap’ stock must have something wrong with it, and an ‘expensive’ stock must be a sign of quality – at least that’s the way we tend to view things.
The Anginer et al study shows some similar findings in the legal context. Ugly defendants get far worse sentences, than attractive defendants. We have a hard time believing that attractive people could have been bad – a kind of halo effect, if you will.
Miguel: This Q/A would not be complete without mentioning the Trinity of Risk. Tell us about the Trinity of Risk. Which of the three components do you think is the hardest to monitor, why?
James Montier: As I mentioned earlier, I don’t think of risk as a number, but rather as a permanent impairment of capital (as Ben Graham put it). Now that permanent impairment can be generated by three potential sources (which aren’t mutually exclusive). Firstly, there is valuation risk – you can simply overpay for an asset. Secondly, there is fundamental or business risk – something goes wrong with the underlying economics of the asset. Thirdly, financing risk or leverage (which no matter how hard you try can’t make a bad investment god, but can make a good investment bad).
I’m not sure that any of them is easier or trickier to monitor. I think you to consider all three aspects in order to gain a holistic view.
Miguel: Why are we so terrible at predicting our emotions?
James Montier: I wish I knew. However, all the evidence shows that we are truly appalling at predicting how we will act in the heat of the moment. On a ‘up’ day in the market we tend to feel confident and happy, and are sure that we would buy more at a lower price. However, when that lower price arrives, we are caught like rabbits in the headlights. Learning to master your emotions is one of the most valuable things that investors can learn to do.
Miguel: You say knowledge doesn’t equal behavior. What a wise statement tell us more.
James Montier: Regrettably, knowledge and behaviour are not the same thing. As you know (because we’ve met) I am a large man (on the BMI I am on the boarderline between overweight and obese). Now I know this, and I know that the easiest way for me to remedy this situation is for me to eat less. Sadly, I love food, and thus I don’t cut down my consumption. So despite my knowledge my behaviour doesn’t change. The same is true when it comes to investing. Realizing that we are prone to behavioural biases is an important first step, but it isn’t enough. We need to force ourselves to actually change our behaviour by altering the way we approach investing.
Miguel: James I have to say I’m confident an investor could read your 10 tenets of investing and with diligence outperform major indices. However, I’d like to ask you to elaborate on several of these principles.
1. Tell us how you look at cycles. Are there any indicators or measurements you rely on?
James Montier: Personally I’ve never really found it that tricky to know where we are in a cycle. There are a lot of indicators that gauge exactly that sort of thing from the ISM to the ECRI measures. The Philly Fed have a good (by which I mean timely) index called the ADS measure which tracks where we are in real time.
2. You praise skepticism…How do you balance skepticism with (a perma bear) bias?
James Montier: To me skepticism means questioning what I hear. That tends to lead to a contrarian perspective. When everything I hear is bullish skepticism leads me to be bearish, and when everything I hear is bearish, skepticism pushes me to be bullish. If this time ever does prove to be different then I’ll miss the boat, but so far it hasn’t proved to be the case.
3. History matters: Name 3 of your favorite financial history books.
James Montier: Kindleberger’s Manias, Panics and Crashes is just awesome. As is Devil takes the hindmost by friend and colleague Edward Chancellor. My third choice would be The engines the move markets by another friend, Sandy Nairn. If I were allowed a fourth it would be J.K Galbraith’s, A Short History of financial euphoria. Studying these four books would do most investors a much greater service than studying for a CFA.
4. I also find your Paul Wilmot and Emanuel Derman Quote quite interesting.
“I will remember that I didn’t make the world, and it doesn’t satisfy my equations”
“Though I will use models bodly to estimate value, I will not be overly impressed by mathematics”
“I will never sacrifice reality for elegance without explaining why I have done so”
“Nor will I give the people who use my model false comfort about its accuracy. Instead, I will make explicit its assumptions and oversights”
“I understand that my work my have enormous effects on society and the economy, many of them beyond my comprehension”
James Montier: I’ve long argued that those of us who work in finance should take a form of the Hippocratic oath- to do no harm. It never ceases to amaze me the way we constantly embrace the latest fad or innovation, when they are just replicates of things we’ve seen before. Take CDOs, they looked exactly like the CBOs which turned up during the junk bond mania of the late 80s. Anyone familiar with that era couldn’t help but notice the uncanny parallels with more recent events.
Miguel: Let’s talk about the work of Lerner & Phil Tetlock: Tell us about the detrimental effects of holding people accountable for outcomes.
James Montier: My work in this field was sparked by listening to gold medal winners being interviewed at the Olympics a few years back. Invariably the interviewer would ask them what was going through their mind before the race started, where they focused on the gold? The response always came back that they were always focused on what they had to do (i.e the process) not on the outcome (the medal).
Process is the one aspect of investing that we can control. Yet all too often we focus on outcomes rather than process. Yet ironically, the best way of getting good outcomes is to follow a sound process. The research shows that holding people accountable for outcomes tends to lead to suboptimal performance, generally because they spend all their time worrying about the things they can’t control. I’d advise a far better approach to assess people on the criteria of adherence to process.
Miguel: Tell us about your research on Bob Kirby’s Coffe Can Portfolios. What do these findings imply about investment behavior?
James Montier: Bob Kirby was an investment great. His writings on investing are right up there with the best, yet he remains a name that is relatively unknown. One of his papers was on the subject of the coffee can portfolio. He harked back to the days of the old west, when people would keep their most prized possessions in a coffee can under the bed. Kirby argued that investors should behave in a similar fashion, and create a portfolio of stocks that they would be happy to hold in a can and forget about (he called this passively active as opposed to actively passive).
Today we seem further away than ever from Kirby’s ideal. It appears as if investors have a chronic case of attention deficit hyperactivity disorder. The average holding period for a stock on the New York Stock Exchange is just 6 months! This has nothing to do with investment, and everything to do with speculation. Having a longer time horizon than these speculators appears to be one of the most enduring edges an investor can possess. If everyone else is jumping around only concerned with the next two quarters of earning announcements, then they are likely to end up mispricing assets for the long-term.
Miguel: Tell us about your deep value screen borrowed from Ben Graham (page 207)
James Montier: Ben Graham is one of my investing heros, so when I came across a screen he’d designed shortly before his death I was intrigued. I set it up and have been running it for over a decade now. The criteria are simple (as is all good investing). The stock must be cheap (with an earnings yield at least twice the AAA boind yield), it must be returning cash to shareholders (with a dividend yield of at least 2/3rds of the AAA bond yield), and it must have limited leverage (with total debt less than 2/3rds of tangible book value). I added one extra criterion, a Graham and Dodd PE (current price over a 10 year moving average of earnings) of less than 16x times. I added this is to prevent us from buying cyclicals which had enjoyed a short sharp run up in earnings, but didn’t have sustainable earnings power.
I’ve used the screen for both top down and bottom up work. The bottoms up benefits are obvious; it can provide us with a list of stocks which make sense as a starting point for a portfolio. From a top down perspective I find the number of opportunities showing up tells me something about the overall state of the market. If I can find a plethora of potential investments then the overall market is likely to cheap (or at least a large part of it) – a prime example was the largest number of stocks passing the screen I’d ever seen in late 2008, early 2009 – which made me feel very bullish. In contrast, the dearth of opportunities in 2007 suggested the need for caution. Right now I’m not finding massive amounts of opportunity, in fact I finding less than half the number of stocks passing this screen now compared with late 2008.
Miguel: Tell us about the folly of using price to sales as a proxy for value.
James Montier: Price to sales is fine if you are looking for short candidates, but as a long side value criteria it makes no sense to be at all. After all as long as you promise to value me on price to sales, I’ll set up a business selling $20 bills for $19…I’ll never make a profit, but if you are looking at price to sales you won’t care.
Price to sales is typical of the drift up the income statement when the bottom line gets too demanding. If your PE starts to look expensive, get everyone to look at a less demanding metric, enter stage left price to sales. If that starts to look tough, abandon the income statement and look at the value based on eyeballs and clicks!
Miguel: What I enjoy about your writing is that you aren’t afraid to talk about “controversial topics” – yes I’m talking about your work on short selling. Can you quickly tell us what you have learned about short sellers (their characteristics, screens, etc).
James Montier: Short sellers are everyone’s favorite scapegoats. They make money when things go ‘wrong’. Of course, what the authorities forget is that simply because a short seller sells a stock, doesn’t mean it goes down – if only it were that easy we’d all be short sellers. As David Einhorn observed, I’m not critical because I’m short, I’m short because I‘m critical.
In my experience, short sellers are amongst the most fundamental investors you’ll come across. They understand the ins and outs of a business better than just about everyone else. They are highly skilled at figuring out poor economics when they see if. They act as acting police, helping to uncover fraud – something that the regulators used to do (a very long time ago).
My own work on short selling has focused on a number of areas. In general, shorts tend to come into a couple of categories: bad businesses (i.e. poor economics), bad accounting (obvious), bad management (the guys at the top haven’t got a clue). In addition I often look for several traits, such as expensive, unrealistic growth expectations, too much debt, and poor capital discipline (i.e. needless and tangential M&A).
I also created a measure called the C-score (C is for cheating or cooking the books). It aims to look for the quantitative red flags which often accompany bad accounting.
Excerpt: Details of the C score Page 263 of Value Investing Tools & Techniques for Intelligent Investment
1. A growing difference between net income and cash flow from operations.
2. Day sales outstanding is increasing.
3. Growing days sales of inventory
4. Increasing other current assets to revenues.
5. Declines in depreciation relative to gross property plant and equipment.
6. High total asset growth.
Miguel: You uncover some fantastic research linking the characteristics of psychopaths with management styles. It seems like your checklist in this area is essentially a screen for narcissism.
James Montier: Yes, this kind of fits in with bad management aspect that I mentioned above. There is some intriguing work arguing that many managers share a lot of traits with psychopaths (minus the violent tendencies). The checklist I use is as you say essentially a screen for narcissism, I’m trying to weed out those who are so caught up in their own self importance that they wouldn’t see a problem coming even if bite them on the ass.
Miguel: James I can confidently say that we are all huge fans of your work- what’s the best way for us to keep pace of your latest writings.
James Montier: You are far too kind. These days you can get my writings from the GMO website, they will even send them to your inbox if you sign up for the white papers. I’m aiming to be writing once a quarter or so.
Miguel: Thanks again for answering our questions. We wish you and your family the best of health.
James Montier: It has been my pleasure Miguel. Keep well.
Miguel: If you enjoyed this interview I recommend reading – Value Investing Tools & Techniques for Intelligent Investment. Also, stay tuned for part 2 where we will discuss James’ -Little Book of Behavioral Investing.
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Other Related Posts From Simoleon Sense:

1. Part 2: Interview With James Montier – The Little Book of Behavioral Investing – How Not To Be Your Own Worst Enemy
2. James Montier: On Most Common Investment Mental Pitfalls
3. James Montier: On Happiness & Investing
4. Miguel Barbosa Interviews Joe Calandro, JR. Author of Applied Value Investing
5. James Montier: Keynes & Risk In Momentum Oriented Markets

FINALLY THE MARKETS ARE STARTING TO EXCITE ME AGAIN

Obviously taking it on the chin month after month is not fun. So being a contrarian in the face of a massive bear market rally has been rather testing.

This is not to say that I may be totally wrong with my bearish views, however, I finally feel the market has done so much in the last few weeks that even if I am wrong I am likely to be right in the short term.

 

 

TOO MUCH OPTIMISM

Mickson agrees the market is way ahead of itself.

 

Real estate investment trust executives at last week’s New York University REIT symposium say they are concerned about the impact that looming debt maturities will have on the sector. David Simon, ceo of Simon Property Group, kicked off the event with a warning that seemed to be at odds with the generally optimistic view of many of the attendees. “I think there is distress out there and it’s fast approaching,” Simon said. “There is $3.5 trillion of debt to deal with. I’m hearing too much bullishness out there, and I’m still cautious.”

Simon’s view was later echoed by none other than William Mack, founder and chairman of AREA Property Partners, and Sam Zell, chairman of Equity Group Investments—the generally acknowledged guru of the industry. The always quotable Zell said, “I think the sentiment is dramatically better than the reality. I think there is still a missing element on the demand side. This is a demand recession.”

Zell wasn’t entirely pessimistic, though, and acknowledged that development has been stalled. “Nothing of any consequence has been built since July 2007. Giving that, we should see significant occupancy increase over the next 12 months, but not at the prices we think,” he said. “The real challenge is to balance out existing supply and what offices are rented out at, which will be lower than expected.”

Across the board, REITs say they are well-positioned to take advantage of distressed opportunities. “The day of reckoning is coming. We see this as an opportunity to look at terrific operators who might have got over leveraged,” says Stuart Koenig, global cfo and chief administrative officer of AREA Property Partners. “If we can provide equity in that capital stack, it’s a great way to get control,” he added. William Hankowsky, chairman, president and ceo of Liberty Property Trust, agreed. “We’re extremely interested in investing and will, if it makes sense. But we’re happy to wait it out on the sidelines until we have the pricing we like,” he added.

For his own part, Mack had a piece of advice for the audience that he said would resonate with the future MBAs who were there. “Be like Rip Van Winkle: go to sleep for three years and when you wake up, it will all be ok!” he advised.

by Joanna Randell

 

iShares Dow Jones US Real Estate

What do you think?

LOVE THIS QUOTE

This quote from one of my gurus an MIT Professor of Math

 

"...if one tortures a dataset long enough, it will confess to anything!"

- Andrew Lo

Mike

 

 

FIB BULLS EYE

IS THIS IT???

END GAME - DEBT CYCLE

I think this quote from John Mauldin is particularly appropriate and it is certainly shaping my thinking as to how I am managing the portfolio.

“We live in extraordinary times. We are coming to the End Game of the debt supercycle that has lasted for 70 years. Everything is changing in front of our eyes. It compels us to understand the basics of how economies function, and what is both different and not different about the times we are in.”

 

CHARTS

 

IS THIS IT???

WESTFIELD LEADING THE PACK

Westfield is continuing to lead the pack lower. We are on the verge of a collapse if support is broken.

 

 

A COUPLE OF BEARISH CHARTS

 

GETTING CLOSER TO COLLAPSE EACH DAY

 

A-ORDS

The charts doesn’t have today’s down 1% included but the market is oversold and due a correction. My best bet would be a relief rally starting with the open tomorrow morning 2 Feb.

There is a lot more weakness to come in this index, only thing that remains as a positive for the bears is that we may be coming down in wave B with C still to come before we collapse.

The reason I say this is because the rally from the March 09 lows can possibly be counted as a 5.

 

NO REASON

I remember reading an idea a few weeks ago describing the stock market crash in 1987, there was no real substantial reason at the time to explain the massive selloff, and the more people phoned around to try and establish what was causing it the more panicked people became when they couldn’t find a feasible reason.

 

The 2007 selloff came at the back end of a hugely inflated market based on valuation and sentiment (read: bullishness and lack of fear, via low premiums); but the market always placed the reason of the selloff on the subprime market, in fact almost everyone called it the subprime crisis, and only later did it become known as the GFC (global financial crisis).

 

Although there are many valid economic and technical market explanations for this selloff, the most recent 10 day selloff is essentially coming off the back of positive economic news, and therefore I suspect continued selling off the back of these headline numbers may be the source of a panic selloff in the weeks to come.

 

3rd of a 3rd

US REITS BREAKING DOWN

TAKEN OUT TREND LINE

The Nov trend line has been taken out convincingly lets see how things develop from here:

 

US RESIDENTIAL RENTS

Take a look at this incredible story, yet Apartment REITs held up strongly.

Something doesn’t add up.

 

WESTFIELD IS TOAST

The chart on Westfield looks really weak, I think this baby is toast, I am still a believer on a relative basis in the A-REITs excl WDC.

VOLATILITY REVERSAL

A BULLISH VARIATION

IYR UPDATES

I THINK FIBONACCI HAS SOMETHING TO SAY

MOOD SHIFT

 

Just a note to myself, I have been in a particularly GRUMPY mood the last 15 hours. It is one of those bad moods for no reason.

As a personal insight I often get these moods when there is a big reversal about to take place in the markets. It doesn’t always mean that it is a reversal in my favour

But often times the market is about to track a new course.

 

MOOD SHIFT

Just a note to myself, I have been in a particularly GRUMPY mood the last 15 hours. It is one of those bad moods for no reason.

As a personal insight I often get these moods when there is a big reversal about to take place in the markets. It doesn’t always mean that it is a reversal in my favour

But often times the market is about to track a new course.

 

DUBAI FORECLOSURE

Something that caught my eye today is a report about the poor state of the housing market in Dubai, values are down more than 50% since last year. People have just been walking away from their mortgage obligations, and until a landmark case recently won by Barclays nobody was showing any foreclosures on their books. Well things are changing now.

 

 

THE NATIVES ARE GETTING RESTLESS

It may just be my bias’ speaking but I pickup in the media that there is growing hostility towards government, big shot bankers, and heaps of other people in seemingly powerful positions.

I sense there is a shift in mood transferring and the canary in the coal mine is the build up of hostility.

AGENT BASED MODELLING & CIRCUITIST THEORY

This is a note to myself.

 

I have gone to great lengths to prove to myself and others that the ability to forecast the market is impossible, at least to any high degree of probability yet I spend inordinate amounts of time seeking a model that puts things nicely into place.

There is no doubt it is the need within me that is seeking an answer to something I know only too well is unknowable, so I decided to be a little indulgent, perhaps it will serve me better to understand the enemy camp a little better.

 

Today was a left brain focused day, where I spent most of it researching Agent Based Modelling & Circuitist Theory.

 

The concept of Agent Based Modelling is appealing to me for a number of reasons. In essence a couple of days ago whilst studying the subject I came across a simulator model that is able to simulate an artificial stock market. The appeal to me is that if one has a really good simulator then one can firstly test some of the models we have been working on, the second appeal is that perhaps then I can forecast the markets (hmmmn what is with me on this subject). To end this section off, I have sifted through heaps of programmes and come across one that I will spend some time working with, it has built in evolutionary and social dynamic models, such like modelling how birds flock, or how rumours are spread, and 100’s more. I guess in a nutshell alot of the behind the scenes thinking in these models is game theory or genetic algorithm based.

 

Circuitist Theory is based on a closed circuit monetary economic model. Such that you break down an economy into a skeleton of variables, and then observe the behaviour of the circuit based on the actions of the agents within the model. As we know the market is not made of supremely rational agents however they do equilibriate to a point. Steve Keen an Aussie Economic Professor is one of the leaders in this field and who writings led me down this path. I find this extremely interesting and I do believe quite logical. It by no means predicts the markets behaviour but can certainly provide a probable string of events based on certain conditions.

 

SO CLOSE

It feels like we are so close to some real interesting market action.

It sure feels like the market wants to punish itself, as no matter how bleak certain macro factors present themselves, Mr Market wishes to choose a positive spin and hence up it climbs.

This cannot go on for much longer as the market internals just do not have enough momentum to drive things up more.

 

I sense the many hours of worry and lack of sleep are about to be rewarded.

POWER OF GIFTS

The Power of Gifts

The nature of social reciprocity may also underpin some of the stranger behaviour of people - the mere receipt of a gift, however pathetic and pointless can trigger reciprocal tendencies. This is partly why the rising internet concept of giving things away for “free” can create viable business models: as Daniel Caldini relates in Influence, the Hari Krishna have long used such techniques to elicit donations from people who’d really rather not give them anything other than a wide berth.

Personally, I find training myself to say “No, go away before I hit you with this handy piece of street art” a lot easier than engaging in the kind of elaborate avoidance strategies erstwhile victims of “free” are inclined to use. Someone selling you something is not your friend. Unless, of course, they are your friend in which case refusing them is almost impossible – hence the wild success of Tupperware parties. Nothing, but nothing, sells like friendship.

In the meantime, however, the lesson for sales people is easy: give stuff away for free and make sure it’s personal. Sod economics, social psychology will do the rest.

 

Source: http://www.psyfitec.com/

 

HUSSMAN ON FEDS new FANNIE MAE BAILOUT

What will be a game-changer is if Congress fails to recognize that the Treasury's action is at minimum an evasion, and possibly a usurpation of powers that are enumerated to Congress alone. If Congress does not forcefully defend that prerogative – even if it ultimately ends up voting for exactly the same policy – it will have relinquished the power of fiscal policymaking into the hands of unelected bureaucrats. This is real public money that is being spent to make bad mortgage loans whole. It may not appear to be costly at present, since risk-averse individuals conscious of credit risks, and foreign countries running massive trade surpluses, are still willing to accumulate the Treasury securities being issued, with no apparent impact. But ultimately, those securities will either stand as claims on our future national production, or they will be inflated away. Either the Treasury securities will retain value, so that holders such as China get to use them to acquire our productive assets in the future, while we ultimately tax ourselves in order to pay off that debt, or we must dilute the ability of those Treasuries to claim real goods and services, which is another way of saying we inflate away the debt. (Hussman, 4 Jan 2010)

 

DAVID TEPPER

David Tepper, Appaloosa Management, Made $7 Billion in the Panic

(GREGORY ZUCKERMAN –  WALL STREET JOURNAL) In this comeback year for investors, David Tepper may have scored one of the biggest paydays of all. Mr. Tepper's hedge-fund firm has racked up about $7 billion of profit so far this year—with Mr. Tepper on track to earn more than $2.5 billion for himself, according to people familiar with the matter. That is among the largest one-year takes in recent years.

Behind the wins: a bet worth billions of dollars that America would avoid a repeat of the Great Depression.

Through February and March, Mr. Tepper scooped up beaten-down bank shares as many investors were running for the exits. Day after day, Mr. Tepper bought Bank of America Corp. shares, then trading below $3, and Citigroup Inc. preferred shares, when that stock was under $1. One of his investors insisted more carnage loomed. Friends who shared his bullish beliefs were wary of aping his moves amid speculation that the government was about to nationalize the big banks.

"I felt like I was alone," Mr. Tepper recalls. On some days, he says, "no one was even bidding."

The bets paid off. A resurgent market has helped Mr. Tepper's firm, Appaloosa Management, gain about 120% after the firm's fees, through early December. Thanks to those gains, Mr. Tepper, who specializes in the stocks and bonds of troubled companies, manages about $12 billion, a sum that makes Appaloosa one of the largest hedge funds in the world.

Mr. Tepper, whose office overlooks the parking lot of a Hilton hotel in Short Hills, N.J., across from an upscale mall, now is taking aim at a new target. He's purchased about $2 billion of beaten-down commercial mortgage-backed securities. Among his purchases are bonds backed by chunks of the debt of Peter Cooper Village & Stuyvesant Town and 666 Fifth Ave. in New York, two high-profile real-estate deals that have fallen in value over the past two years.

Some experts predict more bad news for commercial real estate—and say that if Mr. Tepper's move doesn't pan out, it could jeopardize a chunk of his recent gains. Mr. Tepper says he remains optimistic.

Hedge funds, once darlings of well-heeled investors, suffered dearly in 2008, dropping 19%. Nearly 1,500 funds, or 16% of the total, shuttered last year. This year, hedge funds are clawing back, with gains of 19% through November, on pace for their best annual gains in a decade, according to Hedge Fund Research Inc.

A handful of funds—including Everest Capital's emerging-market funds and the stock-focused Glenview Capital—have racked up fat gains this year. In sheer dollars, though, none appear to have come close to matching Appaloosa's winnings.

Mr. Tepper grew up in a middle-class neighborhood in Pittsburgh, the son of an accountant who worked seven days a week and once won a $715,000 lottery payout. In the late 1980s, he helped run junk-bond trading at Goldman Sachs. Mr. Tepper wears jeans and sneakers to work, and can be self-deprecating, playing down his successes. He claims to have popularized on Wall Street the phrase "it is what it is" to explain the need to adjust a portfolio if facts on the ground shift.

After he was repeatedly passed over for a partnership, Mr. Tepper left Goldman to start Appaloosa in 1993. By 2008, he had a track record of annual gains averaging about 30% and a net worth estimated at about $2 billion.

Mr. Tepper lives in a two-story home in New Jersey he bought in 1990 for $1.2 million. He recently purchased an ownership stake in the Pittsburgh Steelers football team, and flies to every home game. In 2004 he gave $55 million to Carnegie Mellon University's business school, his alma mater, which renamed itself the Tepper School of Business.

The husky, bespectacled trader laughs easily, but employees say he can quickly turn on them when he's angry. Mr. Tepper keeps a brass replica of a pair of testicles in a prominent spot on his desk, a present from former employees. He rubs the gift for luck during the trading day to get a laugh out of colleagues.

His biggest scores over the years have come from buying large chunks of out-of-favor investments. When Asian markets crumbled in 1997, Mr. Tepper added Korean stocks to a portfolio laden with Russian debt. The moves led to hundreds of millions of dollars in profits when markets rebounded two years later. He scored big on junk bonds in 2003, and his 2007 wager on steel, coal and other resource companies paid off in 2008 when commodity prices soared.

But because he sometimes places more than half of his portfolio in a single trade idea, Mr. Tepper also is prone to brutal, abrupt losses.

That approach cost him more than $1 billion last year. In January 2008, Societe General SA trader Jerome Kerviel was revealed to have lost €5 billion ($7.2 billion), one of the world's largest trading loss. Mr. Tepper sold large chunks of his holdings, fearing a market tumble. Prices held up, though, hurting Appaloosa. In the spring of last year, he turned bullish on large-company stocks and did some buying, but suffered as markets declined.

Mr. Tepper made a big wager on Delphi in 2006. But in April of last year he and a group of investors withdrew from a deal to inject as much as $2.6 billion in the bankrupt auto-parts supplier, sparking a nasty legal battle that was resolved this summer. Appaloosa lost almost $200 million on its investment in Delphi.

Mr. Tepper's largest fund dropped 25% for 2008, worse than the industry's 19% average decline.

"Investing with David is like flying, with hours of boredom followed by bouts of sheer terror," says Alan Shealy, a client of more than 18 years. "He's the quintessential opportunist, investing in any asset class, but you have to have a cast-iron stomach." (Mike highlight)

Mr. Tepper entered 2009 cautiously, with more than 30% of his firm's assets in cash, or more than $2 billion. He itched to do some buying. Mr. Tepper explains his investment philosophy with a line from Allan Meltzer, a professor at his alma mater: "Trees grow." In other words, growth is the natural state of economies, so optimism usually is rewarded.

On Feb. 10 of this year, Mr. Tepper read that the Treasury Department was introducing the so-called Financial Stability Plan. It included a commitment by the government to inject capital into banks by buying their preferred stock, or shares that carry less chance of reward but also less risk than common stock.

At the time, investors worried that the government ultimately would have to nationalize big banks. U.S. officials said they had no intention of such a move, which could wipe out common shareholders, but investors were dubious.

The news from the Treasury Department struck Mr. Tepper as proof that the government would stand behind the banks. He directed his traders to begin buying bank stock and debt.

Few investors were feeling as optimistic. The Dow Jones Industrial Average fell more than 382 points on the day Treasury Secretary Timothy Geithner introduced the plan, nearly 5%. Bank shares continued to tumble in the days that followed. Bank of America shares fell as low as $2.53 on Feb. 20. By March 5, Citigroup traded as low as 97 cents.

"This is ridiculous, it's nuts, nuts, nuts!" Mr. Tepper recalls saying to Michael Lukacs, one of his partners, on the firm's small trading floor. "Why would the government break its word? They're not going to let these banks go under, people aren't being logical!"

Mr. Tepper huddled with Mr. Lukacs and Jim Bolin, another top Appaloosa executive. Mr. Tepper insisted that stimulus spending and low interest rates would boost the economy. He said he estimated there was only a 20% chance that the U.S. would nationalize banks such as Citigroup.

Mr. Bolin, who people at the firm say tends to be more conservative than Mr. Tepper, was bullish about banks, but still thought it safer to stick to bank debt than to riskier shares. Mr. Tepper says he listened to the arguments, but said it was time to place a big bet.

Over several weeks, Mr. Tepper's team bought a variety of bank investments, including debt, preferred shares and common shares. Just months earlier, the government had injected billions of dollars to keep companies such as American International Group Inc. going, much as they were now doing with the banks. But that didn't prevent shares of those companies from tumbling.

At one point in March, the firm was down about 10% for the year, or about $600 million. Mr. Tepper got on the phone to make more trades, something he often left to subordinates. This time, he wanted to talk directly to Wall Street brokers to test how bad things really were.

The answer: really bad. Mr. Tepper says he was told that he was the only big investor doing much buying.

"Clients were nervous that the game had changed and capitalism wouldn't be the same. There was real fear," recalls Timothy Ghriskey, chief investment officer at Solaris Asset Management, a $2 billion investment firm, who says he only bought a small amount of bank shares during this period.

One day in late winter, Mr. Tepper heard from a skeptical client of his own, Mr. Shealy.

"This thing is far from over," Mr. Shealy recalls saying, referring to the bank problems. Still, Mr. Shealy, who runs an investment firm in Boise, Idaho, stuck with Mr. Tepper. "I figured the positions were fairly liquid, so if he was wrong, he would get out."

Mr. Tepper hadn't paid his investors' nerves much heed since 2000. That year, he bet that the tech-heavy Nasdaq index would fall. But so many investors complained that Mr. Tepper was straying from his roots in debt investing that he canceled his bets. When the Nasdaq collapsed months later, Mr. Tepper fumed.

By late March of 2009, Citigroup shares had tripled, and Mr. Tepper's other holdings, including junk bonds, were rising. He and his team bought more, spending more than $1 billion, when various banks conducted share sales. Mr. Tepper says his average cost for shares of Citigroup was 79 cents; for Bank of America it was $3.72.

At one point in the summer, Mr. Tepper had recorded about $1 billion of profits in shares of just Citigroup and Bank of America, and his overall gains soared past $4.5 billion, or 70%, since January.

After Mr. Bolin, the Appaloosa executive, urged caution, Mr. Tepper did some selling to lock in gains. But the firm remains a big holder of both Bank of America and Citigroup shares, which now trade at $15.03 and $3.40, respectively.

Mr. Tepper remains upbeat. He says he expects interest rates to stay low, and argues that stocks and bonds are reasonably priced.

This belief is driving another risky bet. At the end of each quarter this year, Mr. Tepper noticed that investors were dumping holdings of troubled bonds backed by commercial properties. He had never dabbled in these investments, but he and his 10-person team did some research and judged them attractive, with some seemingly safe debt trading at yields above 15%.

Mr. Tepper slowly spent more than $1 billion to gain ownership of between 10% and 20% of highly rated slices of commercial mortgage-backed securities, or CMBS. He focused on debt backed by loans of properties including Stuyvesant Town and 666 Fifth Ave. in New York.

His bet: If the economy improves, he'll earn hefty interest payments on the bonds. But if the properties can't make their payments, Mr. Tepper believes he owns so much of the debt that he'll have a big say in how the properties get restructured. That means he could ultimately end up ahead.

He's taking a big risk, some analysts warn. The value of commercial real estate continues to fall. Owners of debt classes don't always have much power to influence a commercial real-estate restructuring. And because the debt of these big properties was carved into many pieces, and many investors are involved, any battle for control will be complicated.

Mr. Tepper says the worrywarts have it wrong: "If you think the economy will be fine, as we do, then we're going to do very well."  Full: http://online.wsj.com/article/SB126135805328299533.html

 

BURJ KHALIFA

The financially troubled Gulf emirate of Dubai has opened the world's tallest building, a glistening concrete, glass and steel pinnacle rising 828 metres out of the desert sands.
He renamed the building, previously known as Burj Dubai, Burj Khalifa in honour of United Arab Emirates President Sheikh Khalifa bin Zayed al-Nahayan.

Opened with a bang ... fireworks explode around the world's tallest skyscraper. Photo: Reuters

Sheikh Khalifa is also ruler of Abu Dhabi, the emirate which came to Dubai's help late last year to the tune of $US10 billion ($11.15 billion) to bail out troubled property developer Nakheel, a subsidiary of Dubai World.
"Today the United Arab Emirates achieves the tallest building ever created by the hand of man... and this great project deserves to carry the name of a great man. Today I inaugurate Burj Khalifa," Sheikh Mohammad said.
Emaar Properties, the partly government-owned developer, had maintained the suspense about the skyscraper's final height, saying only that it exceeded 800 metres.
On Monday it said the tower had more than 200 floors, only 160 of which would be inhabited, while the remaining floors were for services.
Burj Khalifa has a total built-up area of 530,000 square metres, including 170,000 square metres of residential space and more than 28,000 square metres of prime office space, Emaar said.
This amounts to 1,044 apartments and 49 floors of office space, served by 57 lifts. It also has a hotel carrying the Georgio Armani logo.
Bill Baker, a structural and civil engineer and partner in Chicago-based Skidmore, Owings and Merrill (SOM), which designed the tower, said it has set a new benchmark.
"We thought that it would be slightly taller than the existing tallest tower of Taipei 101. (Emaar) kept on asking us to go higher but we didn't know how high we could go," he said.
"We were able to tune the building like we tune a music instrument. As we went higher and higher and higher, we discovered that by doing that process... we were able to reach heights much higher than we ever thought we could."
A spiralling Y-shaped design by SOM architect Adrian Smith was used to support the structural core of the tower, which narrows as it ascends. Higher up it becomes a steel structure topped with a huge spire.
To reach the final stages, concrete was propelled to a height of 605 metres - a world record.
The inauguration of the tower comes, however, after the once-booming real estate sector of the emirate has crashed, halving the value of most Dubai properties in comparison with peak prices recorded in the summer of 2008.
It also comes as Dubai battles a serious debt crisis, resulting from the heavy borrowing by some of its state corporates to finance imposing property projects.

TATTOOS

Apparently towards the end of 1929 there had been a dramatic increase in the number of people sporting tattoos. In Australia and Sydney in particular the number of people with tattoos is quite staggering.

Already in the US there appears to be a large increase in the number of people seeking their removal.

As a kid growing up I recall seeing very few people with tattoos and the bulk of the people were either from England or sailors.

I suspect we will see a decline in Australia only once unemployment reaches levels of concern. By the way there are 2 reality shows in the US focusing on the art of tattooing, so that just gives you an idea of the craze. And of course if little miss popular Miley Cirus just got one then you know that we are still in a bullish social mood.

PARITY ????

As a contrarian, I am not so convinced.

Analysts tip $A parity with greenback by year's end

CLANCY YEATES

January 1, 2010

THE Australian dollar is set to climb higher this year as the economy moves up a gear, analysts say, and parity with the US dollar remains a strong prospect.

AUSSIE SMACK

The people in this “lucky” country (Australia) as they call it have developed an economic/success arrogance just like their cricket team of the late 90’s early 2000’s. Aussies have enjoyed tremendous wealth through the commodities and housing boom, this has lead to consumption economy used to high levels of debt. It has also built that self fulfilling feedback loop that things can only go on and get better. Just like being number one in cricket the only place left is to go down. I believe this is what awaits the future of the Australian economy.

 

It is clearly impossible for the current levels of debt to be sustained. Take a look at this startling factoid that appeared in the local press a few days ago. What has in fact happened is that the belief in the success has resulted in a bubble economy, i.e. housing/mortgage and commodities. Any deflation in these assets and the result will be devastating.

 

MB

 

IN a new record, Australians now owe more in household debt than the country's entire economy earns in a year.

Reserve Bank figures show mortgage, credit card and personal loan debts now stand at $1.2 trillion, up 71 per cent from just five years ago and equating to $56,000 for every man, woman and child in the country, News Ltd says.

Our spending binge, fuelled most recently by the federal government's First Home Owner Grant, means personal debt now totals 100.4 per cent of Australia's annual GDP - one of the highest ratios in the developed world.

"It's the first time household debt has cracked 100 per cent of annual GDP and it's a terrible, terrible sign,'' University of NSW economics professor Steve Keen told News Ltd.

"It shows we are living beyond our means and many highly geared borrowers are now extremely vulnerable to further rate rises - they are already saturated with debt and will not be able to tolerate much of an increase to their repayments.''

Our financial headache is likely to get worse before it gets better. We are in the midst of the peak spending season when billions goes on the plastic, yet the Reserve Bank data dates back to October's debt levels only, so that means there are another two months of First Home Owner Grant-fuelled mortgage activity still to be taken into account.

The extra cost is expected to add billions to the burgeoning debt tally.

 

STAR FADING

I cannot help but feel this Star is about to start fading. He has become way to much a part of the popular press and is enjoying his current oracle status.

I think he is Long and Wrong.

 

Paulson Has Never Been More Long   posted by holdenr on Wednesday 9 Dec 2009 08:45 GMT
From Post Chronicle - see full story

From The Post Chronicle: Billionaire hedge fund manager John Paulson said on Tuesday he still sees compelling long-term returns in equities even after their sharp run-up this year, while holding no short positions in the credit markets.

"Today our net long exposure is perhaps the highest it has ever been in our portfolio," Paulson said during a luncheon presentation at the Japan Society.

 

BAD DEBT

quote from Carmen Reinhart, “In America, the Fed has injected a lot of money into the economy as a response to the crisis. Right now the Fed has about a trillion dollars of Fannie and Freddie on their balance sheet, and that's not going to turn out very well, and it hasn't been recognized.”

A COUPLE OF REIT CHARTS

 

WESTFIELD

I have maintained for some time; keep an eye on Westfield this Australian stock may be the leader in the field.

THE DAX

I never quite realized what a major tripple top this was

COLLECTIVE UNCONSCIOUS

The Global Financial Crisis has given people interested in crowd behaviour incredibly rich material to apply and explore some of the more famous psychological and philosophical theories advanced by the giant “thinkers” of bygone eras. My passion lies in the epistemology that drives the crowd to herd in a seemingly irrational manner when factual information seems to require such contrasting behaviour.

My journey for this article began with the reading of a very different type of autobiography whereby Carl Jung writing in his 80’s recounts vivid memories and observations from age 3 all the way through his adult life, “Memories, Dreams, Reflections by C.G. Jung”; a fascinating article by Pulitzer Prize winner Anne Crittenden, entitled “The Stock Market Scene Today: A Jungian Perspective” providing the central theme to my article, and finally an excellently crafted critique on the comparisons of two famous thinkers “Nietzsche and Jung: The Whole Self in the Union of Opposites, by Lucy Huskinson”.  This literary journey coupled with my personal experience sparked a metaphysical phenomenon in me that both Nietzsche and Jung would describe as the process of uniting opposing forces resulting in personal growth leading to The Ubermensch (to quote Nietzsche) or Individuation (to use a Jungian expression).

Before I reveal my observations let me briefly introduce you to Jung, so to speak. Jung was born in Switzerland in 1875 and started his career as a medical doctor. He was closely associated with Freud in his early years but eventually split from Freud and developed his own branch of psychology called, “Analytical Psychology”. Whilst he believed in the personal unconscious like Freud he fundamentally differed with him as to the source of the unconscious. Freud believed it was entirely derived from within, via sexual repression whereas Jung believed it was derived from an external source or factor.

Jung essentially saw the structure of the human mind as comprising 3 parts. The first part being the rational mind or self. The second part the personal unconscious, while playing an important part in the individuals personal progress it plays only a minor role in developing herd behaviour at the collective level. The third and most famous part and the source of most of my interest is his concept of the “Collective Unconscious” which is rooted in the primordial collection of psychic energy across multiple generations housing, instinctive energies and effectively influencing the way we tend to feel about and interpret things. According to Jung these Collective Unconscious thoughts can be seen in the form of mythical characters or religious motif’s which he calls – “Archetypes”. This metaphysical psychic energy – Archetype, is so powerful in energy charging that in many instances when an individual is able to identify with a particular archetype it has the ability to overpower ones rational thinking selves. In cases where a society as represented by collective social mood identifies with an archetype(‘s) then the result is often – Mania.

At the centre of Jung’s beliefs is a process he calls “Individuation” in which individuals are pushed to achieve personal growth by balancing the opposing forces that become evident at a conscious rational level with those unconscious (archetype) forces pulling us in opposing directions. Failure to control the rational conscious man with the unconscious mind leads to what Jung calls an “inflated ego”. Jung believed the psyche would “constellate” the conscious mind in an effort to balance the opposing forces within, and where an opposing force develops sufficient dominance over the other, the result is usually a neurosis or an explosion of emotional behaviour.

What we are going to analyse is how an imbalance is created when a collective society so embraces an archetype that the rational conscious mind is dominated to a level that results in a Mania. Jung explained in detail how unhealthy it is for a society to be too attached to its collective unconscious. At these times society is prone to stray from its rational barometer and develop extreme behaviour with a catastrophic reversal being the end result, he called this reversal “enantiodromia” after Heraclitus an ancient Greek philosopher, who believed the world existed in flux and therefore needed a constant rebalancing. I call it simply reversion to the mean.

Allow me to set the scene during the 1^st quarter of 2009 for a representative look at how world stock markets “constellated” social mood as represented by our “collective unconscious”. The financial system throughout the world was crumbling at its very core, the world seemed doomed to a depression the likes we had not seen in 75 years, and panic was the order of the day. In short the world was in need of a super hero - a saviour. The saviour archetype was well documented by Jung in 1936 as he witnessed the rise of Nazi power in Germany. Officially on 20th January 2009 Barack Hussein Obama II became the 44th President of the United States of America and to a large extent became the financial worlds hero tasked with saving the world; this worship extended so far that he became the first recipient of a Nobel Peace prize in advance of the supposed work he would do in war-torn countries (how ironic that he now endorses President Bush’s war in Afghanistan by sending more troops to the battle line) . There are other notable saviour archetypes on the world stage at present some of which are already seeing the dimming of their proverbial stars, e.g. Ben Bernanke, Tim Geithner, Gordon Brown, Jean Claude-Trichet, Warren Buffet (star still intact), etc. Most notably the leader of the “saviour” pack is not actually a living body as such but more like a representative deity in the form of the world’s Central Banks with the US Federal Reserve dominium occupying centre stage. There is almost universal belief in the power of these central banks ability to avert the current crisis by applying a serum (debt) which was in fact the very cause of the underlying financial crisis. This seeming “alchemy” (a subject which fascinated Jung) which I will call “financial engineering” at the Central Bank level, has introduced yet another archetype on our collective unconscious which together with the saviour has driven our current stock market to manic proportions, with our conscious rational minds completely in awe of the seeming magic and unearthly power these bodies currently wield. There is more.  Crittenden refers to Mircea Eliade a leading scholar of comparative religions and his book Myths, Dreams and Mysteries where he describes the archetype of ascension and she parallels the ascension archetype to the ever upward incline of the stock market during the late nineties. I wish to extend her stock market ascension archetype to the current ascension the stock market has enjoyed from March 2009 until now, where there has been so little pause in the amazing climb that it no doubt conjures up majestic imagery.

We now have a collective unconscious that has been so enraptured with awe at the cosmic majesty of one amazing archetype after another that the embracing collective psyche of our society has effectively abandoned clear rational thought in favour of fantasy. As an intuitive contrarian and a believer in the reversionary powers of the market and the broader Universe, we are likely to feel the dramatic “enantiodromia” effects of a reversal in the markets fortune in the months and possibly years to come. To end with a quote from Crittenden, “Jung never tired of pointing out that only highly developed consciousness of the power of the unconscious can enable an individual to withstand the power of the psychic flood sweeping everybody along. There is nothing more isolating than maintaining one’s individuality in a mass mania”.

OPTION PORTFOLIO

I am hurting!!

SUCH CONVICTION

You have to marvel out how the so called experts can make a call with such conviction with so little evidence.

 

* Bloomberg reported that according to the California Association of Realtors, single-family home prices in California — the epicenter of the housing market's collapse — edged up 0.3% in October from the previous month to mark the eighth monthly rise in a row. Also, sales of existing homes moved up 1% last month from a year earlier. "California has hit and passed the bottom of this real estate cycle," Leslie Appleton-Young, vice president and chief economist of the Realtors group, said.

LET THE FUN AND GAMES BEGIN

 

CONVICTION

Any fund manager who has had massive conviction in a trade will be able to relate to this article on Clarium Management.

Mick.

PS. Some of those monthly returns are “smoking”.

 

Off the Simon Kerr Blog site. http://simonkerrhfblog.blogspot.com

 

Wednesday, 25 November 2009

The Limits to Fundamental Conviction – Clarium Capital

In August 2007, perfectly catching the first public intimations of a financial downwave global macro manager Clarium Capital, then of San Francisco, dispatched a manager letter that took a negative view on economic growth, real estate and the stock market. In the letter they wrote ""We have begun a post-Long Boom phase that can be called the Long Goodbye. Returns during the Long Goodbye will be lower -- perhaps half as much -- than those of the Long Boom."

The firm argued that the developed world has entered a period of lower returns in which interest rates and economic volatility would increase while growth in corporate profits and global expansion decline. To adjust to this new reality, the firm explained that people must work more, consume less and compensate for lower returns by using more leverage -- borrowing more, that is. The prudent response would be to work longer and cut consumption, but up to that point the reaction had been just to borrow more, Clarium said.

Chillingly, Clarium predicted "that higher leverage has made markets much more vulnerable to outside shocks that will force "painful" de-leveraging and a reduction in liquidity."

Clarium built these economic scenarios and market forecasts into portfolios through several investment themes. One was being short the US Dollar, and another was shorting shares of leveraged companies. In the second half of 2007 and early 2008 Clarium made stand-out returns on these themes (see table).

2007 Returns

2008 Returns

Clarium's excellent research had also put them into the camp that believed in the peak oil concept, making oil prices more sensitive to small changes in the demand/supply balance, and giving prices an upward bias over the long term. As it turned out, Clarium's investors didn't have to wait for the long term to arrive and for a payout on the long energy positions Clarium ran – in the first half of 2008 the oil price accelerated to the upside and Clarium's returns reflected big long exposure to energy, gaining 11.2% in May 2008 and 16.0% in June.

So in the middle of last year Clarium Capital's principal, Peter Thiel, was a "Master of the Universe". In the first six months of 2008 his Fund was up 57.9 percent. Significant inflows followed the turn of the year returns, and by the end of July 2008 Clarium Capital Management had assets under management of $7.3bn.

Clarium stayed short of the US Dollar and long energy as the start of the second half of last year, so in July and August gave back some of the gains of the first half of 2008. Bets against the world's reserve currency, the US Dollar, in a time of crisis would not have helped returns at the time of the collapse of Lehmans and the follow on problems at AIG and the UK banks (October/November last year). So after a bang-out first half, Clarium ended 2008 having made a small loss of 4.5%. Better than most hedge funds across all strategies, but the Clarium returns in the second half of 2008 were worse than the peer group global macro managers, and across the whole year the small loss was delivered to investors with very high volatility. Many macro managers run steepener trades as portfolio insurance for a liquidity crisis, so many macro managers were positive in each month of the final quarter of 2008. Clarium didn't carry that insurance and had losses in two out of three months. Like the whole industry Clarium Capital suffered major redemptions in 2008, but the scale of some of Clarium's monthly losses hastened investors to the exit. AUM were $2.5bn at the end of 2008

2008 Returns

Peter Thiel has been quoted as saying recently that "There was a degree to which the financial economy has been extremely decoupled from the real economy." He has noted that he didn't expect the S&P 500 to rally 62 percent, its steepest advance since the Great Depression, at the same time that the proportion of Americas without a job rose to a 26-year high. The Clarium fundamental call has been that the economic recovery would be at best constrained.

"A real, sustainable recovery is not possible without productivity growth," said Clarium's Chief Economist Kevin Harrington. "The recovery is not real," he says. "Deep structural problems haven't been solved and it's unclear how we will create jobs and get the economy growing again -- that's long been my thesis and it still is." He continued, "The government has helped stabilize the banking system, but I'm not sure we have a path toward sustainable growth, partly because consumers are dealing with debt and other issues, even as an energy crisis looms. It always feels unpatriotic to be negative. But too few people are focused on the real problems."

Thiel himself is of the same mindset: "I don't think that a recovery is impossible. I do think its quite hard to get to a situation where you have a lot of growth in the economy without running into basic constraint problems.

"The key thing in the US is going to be doing more with less. If you try to do the recovery by just doing more of the same and if the recovery is going to consist of going back -- to the housing bubble, going back to leveraged finance, lending money again like crazy, going back to 2005 -- it just seems to me like you're setting yourself up for a real problem. I think you would run right back into four dollar a gallon gas prices and it would sort of correct itself [back into recession].

"Longer term I'm hopeful. I'm not wildly optimistic…But I don't think it gets driven by the financial system or even has that much to do with macroeconomic policy. I think it basically has to do with getting innovation working again. I think that's a very long term trajectory. I'm pessimistic in the sense that I don't think people are focusing on that enough."

Implementing these views Clarium was long the Yen and Dollar in the first quarter of 2009. . The Dollar positioning in the first half reflected an implicitly deflationary view, and Clarium has been long of high-quality bonds based on the view that fear will prevail in markets in 2009. That fear in terms of stock markets peaked in March, and since then stock markets have rallied hard. It appeared to the investment professionals at Clarium that valuations on equity markets quickly became rich, and they have shorted stocks into the middle of the year. And paid for it:

2009 Returns

Global macro managers are paid to take a view on how the economic environment is going to impact market prices. If markets reflect the fair values of stocks, bonds and the parities of fx rates global macro managers have no trades to put on. They trade on where prices are going, given their view on the dynamics of economic growth, final demand, inflation and job growth, in the context of markets subject to the emotions as well as the rational thinking of investors.

Modern form macro funds aim to have five or six themes running in their portfolios. The themes are only distinct to the extent that they are uncorrelated. So if two trades are long yen call options as a probabilistic bet that the carry trade unwinds in emergencies, plus a yield curve steepening trade then there are two trades that will work for the same scenario, and they will be tightly correlated when you expect them to work. Long gold and long index-linked bond trades can be thought of the same way.

Late last year was a period when correlations between positions were either +1 or -1. So it was very difficult to construct trades with a macro take on markets that were not very correlated (positively or negatively).

Many managers in macro use VaR type measurements of portfolio risk. This methodology is flawed but still useful for macro managers because it allows risk assumption across different asset classes to be measured on a common basis. Although macro managers are not as micro-controlled as equity hedge managers in risk-assumption boundaries they can and do vary risk assumption according to shifts in markets, including regime change, which is what we saw in the Autumn. So macro managers have a free choice about maintaining, increasing or cutting their risk assumption as market values move, just like hedge fund managers in other styles.

One of the tenets of running money, particularly for other people, is that you earn the right to take risk. On an individual level Peter Thiel did that by co-founding PayPal, and so started Clarium with capital which was merited. The annual return series for Clarium given below shows the classic global macro pay-off profile: the portfolio is run as a series of bets some of which become highly profitable. In concept a global macro fund runs a series of themes are run to give a chance to smooth out returns, and losses are limited by three things: trades which have natural downside protection (like the bond floor of convertibles, or a hard asset value), strategies are put on with delineated stop-losses from the outset, and options are used to implement the views. So the return series should look like a strip of option positions – occasional big pay offs interspersed with dull returns (small losses and small profits).

Annual Returns of Clarium LP

In the case of Clarium several of the tenets of running money, and running money in the modern global macro format specifically have been broken. These are matching stop-losses with the risk/return profile, diversification of theme, and arguing with the market without a suitable limit.

There have been 14 double-digit monthly returns in the Clarium performance history, both gains and losses. That scale of monthly return is only feasible with the use of leverage. The use of leverage carries the inference of high conviction and/or investing capital in low volatility assets. Soros used leverage (re-hypothecation) on his bond positions in his heyday, and traded forward currencies in large size using the implicit leverage of forwards with no margin in low volatility instruments. So leverage per se is not a bad thing, and in normal markets is necessary to potentially generate 20% absolute returns from low volatility instruments.

Soros used to load up on a position when it started to turn his way - the foot-to-the-floor version of risk assumption. That is the investment hypothesis had been tested in the market and shown to be positive, so reinforce the winners. Contrarily, the markets are very good at teaching lessons in humility – so if a position started to ship losses Soros was all over it , and mentally able to cut it and re-visit at a more opportune time. So capital was dynamically applied at Soros Fund Management with the feedback loop of the P&L delivered by the positions in the market.

The other feedback loop that managers use is the fundamentals – have they mapped out as forecast? Is the road-map of the progress of the macro factor turning out as expected at this point? Some, indeed many, managers will argue with markets (running a negative P&L) on the basis that their fundamental view is being borne out in the real world away from traded markets. So if trade deficits are the key factor in monitoring fx rates at the time, and the trade balance is progressing as expected then managers give themselves the right to argue with the markets for the time until their conception is generally recognised in FX cross-rates. Of course there may be other factors influencing the fx rate, and the rate of progress may not be as laid out in the road-map. There is room for judgement, but not for behavioural biases counter to the facts.

In the case of Clarium the losses of August and October last year are prima face evidence that the tenets of macro management were not being followed. If there were effective stop losses at the portfolio level or by theme and the portfolio themes were indeed non-correlated then a single month's loss should not reach 13 or 18%.

As stated, last Autumn was exceptional in the shift on volatility and correlation. However part of what investors pay for in the modern hedge fund world is superior risk management. Exposures should be cut at a hedge fund at the portfolio level to ensure that the target maximum monthly loss should not be breached. Clariums' track record from 2002 to 2007 showed 3 monthly losses of 11% or just over 11%. Given the size and number of positive months that maximum monthly loss was (just) tolerable. But a loss of 18% was not and is not. Exposures should have been cut intra-month so that the target maximum loss was not exceeded. As much as anything else that was a logical reason for investors to withdraw their capital, as they did towards the end of last year at Clarium.

This year is different again. It is clear that the Clarium view on the economy is the same now as it was at the beginning of the year. That is fine – it has been a disappointing economic recovery in some senses, and so in macro-economic terms Clarium have been broadly correct this year, and may be borne out on their forecasts beyond this year. How those views have worked out in traded markets has been less successful – Clarium were down 15.8% by the end of September.

It looks like September 2009 has been a signal month for Clarium Capital Management. The Clarium Fund lost 8% in the first 14 trading days of the month. Between between Sept. 11 and Sept. 19 Clarium cut leverage from 4.2 times down to 1.4 times equity, and closed the month with a loss of 8.1%.

I would contend that the commercial position of Clarium Capital Management LLC was different this year than during the rest of Clarium's history. The large losses of August and October last year, the withdrawal of investor's capital last year, the increase in frequency of losing months, and the fact that the Fund is well below its high water mark (so vulnerable to staff losses) all shout to me that the remaining capital ($1.6bn at the end of September 2009) should be run more conservatively than hithertofor.

I do not think that managers in the position that Clarium was in this year should argue with the market to the extent in terms of scale and time that Clarium did. Being right on the economy only mitigates the position to the extent that positions in markets make money. There are natural limits to risk assumption in global macro, and to an extent Clarium lost some of its degrees of freedom in that regard from the outcomes last year. This year the natural limits to fundamental conviction for the firm should have kicked in a lot sooner than September.

The above was put together using material from various sources. I acknowledge the use of quotations and data from Bloomberg and The New York Post. The use of appropriate feedback loops and money management are core concepts used by Enhance Consulting, Simon Kerr's consultancy.

useful link: manager letter (April 2009)

 

WESTFIELD

It seems that Aussie REITs are continuing to lead Global REITs to the downside. You will remember that Aussie REITs lost about 70% of their value in round 1 of the GFC whereas the US only lost 50%. The current leadership to the downside may be telling us round 2 of the GFC has actually begun.

NYTimes: Third-Quarter U.S. Growth Revised Lower

Amazing how the downward revisions get so little press. The mass
manipulation of the publics perception is quite remarkable.

From The New York Times:

Third-Quarter U.S. Growth Revised Lower

The government said the economy grew at a 2.8 percent pace, instead of
the 3.5 percent growth rate it estimated a month ago.

http://s.nyt.com/u/CF8

Get The New York Times on your iPhone for free by visiting http://itunes.com/apps/nytimes

Sent from my iPhone