The History of the Castrati

I watched a play on the castrati last night. While the play itself was a bit out-in-left-field for me, it was interesting in that I had never heard about the castrati (yes, history was always a weak spot). These were boys who were castrated for the purpose of becoming great soprano players. I thought this might have been a myth, but this article from the Urological Sciences Research Foundation website suggests there were valid medical reasons why this was the case.

The genital mutilation caused a unique physical appearance too. An excerpt from the USRF article:

The manner in which the castrati appeared to their audiences can be judged from our clinical experience of eunuchoidism due to spontaneous primary hypogonadism. A tallness of stature, which was unusual in the 18th century, was commented upon by contemporary writers and was due to failure of the epiphyses to close at puberty, thereby allowing the unopposed action of growth hormone and other growth factors. There was a smooth pale skin, with, later in life, fine wrinkles around the eyes, no beard, plentiful scalp hair, a tendency to obesity, rounding of the hips, and narrowness of the shoulders; the pitch of the speaking voice was similar to that of a female.

I did find some disparities between what I read online and what was talked about in the play, so I guess take I have to everything with a grain of salt, unless I decide to make a trip to the library.

Dow Weighting

I've never been a fan of the Dow Jones index, but now there are distortions that make it seem downright silly! From John Maudlin's latest commentary citing Jim Bianco:

...if C, BAC, GM, AA, JPM, AXP and GE all open at zero, the DJIA loses 528.63 points. If IBM opens at zero, it loses 652.95 points [IBM has risen since then -- JM]. So, the DJIA says that IBM has more influence on the index than all the financials, autos, GE, and Alcoa combined.
The DJIA is not normal as the index committee is not doing their job during this crisis, possibly because to the political fallout of kicking out a Citi or GM. As a result, this index is now severely distorted as it has a tiny weighting in financials and autos.

I.O.U.S.A.

I've been wanting to watch the documentary film, I.O.U.S.A for a while now, and thankfully the movie makers have produced a 30-minute version you can watch for free on their website. This is a must-watch movie on how much of a debt crisis the US faces, with some nifty graphics and historical perspective. Watch it ... trust me, you'd be glad you did!

Get Ready for A Second Wave!

Just when things seemed to be looking up, looks like they're getting worse. Suddenly, job losses ... big ones. The unemployment had been creeping up, and that was no surprise in a recession, but suddenly it seems things have gotten a lot worse. Bloomberg reports 21,000 job losses in a day, by companies such as Hertz.

Circuit City's liquidation was big news, because it means another 30,000 decent-paying jobs, but also this - would people keep buying electronic items if they were nervous the companies that sold the products would not be in business?

Intel saw a 27% drop in revenues. That's from a company that's in a duopoly competition with a weak competitor!

And there's more bad news I could whip up from the news. And I think we'll get a lot more coming this year. But there's some perspective we need to maintain here ...

Take that 21,000 jobs in a day. It scared the bejeezus out of me! It's a big number. It's a lot of families that have to suffer. But it's about 0.01% of the American labor force. Unemployment might have cracked 7%, but it's still a lot below historical highs.

And take all this talk of the Great Depression. I don't know of anyone calling for GDP to drop 5% this year, or in any year. If my memory of history is correct, the Big Kahuna shaved 30% from GDP. Ouch!

So take a deep breath! Things will get worse. A lot worse. But we'll all survive.

Geithner Must Go!

So there's been some red faces over the recent revelation that Treasury Secretary nominee Tim Geithner did not pay his taxes from his IMF job from 2001 through 2004. After an IRS audit flagged his 2003 and 2004 returns, he paid the taxes for those years, but did not pay his overdue taxes for 2001-2002 until the Obama transition team pointed it out shortly before he was nominated.

President-elect Obama seems to be willing to call it an "innocent mistake", as do many in the press, but hold on! This isn't Rep. Charlie Rangel, who underpaid on his taxes. That was embarrassing because Rangel heads the committee that oversees the IRS. Geithner was working all those years and paid ZERO in taxes. That wasn't oversight, it was an attempt to defraud!! The alternate explanation is that he is pretty darned inept, which should rule him out as a custodian of our billions. Either way, this incident should disqualify him from becoming Treasury Secretary.

How Cheap is the Market? (corrected)

I have run a few models suggesting decent long-term returns, and might chose to share those results at some point, but in the meanwhile, I thought some perspectives on valuation and expected long-term returns in the stock market.

Much of the gyrations on Wall Street deal with predicting what's happening now or next year, whereas the true driver of long-term returns is valuation and long-term earnings growth. The problem is Wall Street values the market on a multiple of recent earnings, which are highly volatile. Take a look at the chart below:


The blue thin line and thick trendline are the trailing 12 month (TTM) earnings for companies that make up the S&P 500 index. The problem with the traditional way of valuing the market using a multiplier of TTM earnings (or worse, some future year's earnings) is that it indicates that the market is worth 46% less now that it was a few years months ago. Indeed, that's consistent with the sell-off we see in the market, but for a long-term investor, is a whole bunch of bull!!

The pink line and red trendline represent a 10-year moving average of the TTM earnings. Essentially you are smoothing historical earnings to make long-term decisions while smoothing cyclical variability. Voila, it's fairly smooth. For a long-term investor, the market value hasn't changed in the last few years months - only the price.

So what does it all mean? The next chart is the S&P 500 price history, and the trend of 12, 16 and 25 times the 10-year earnings average. Think of this as a low, median and high value. I have been working on charts since 1910, but I need to verify a few things, so I'll only present the last almost 15 years.


Notice that the big crash in 2000-01 did not make the market cheap. It just took the market from ridiculously overvalued to expensive. And that explains why we have had mediocre returns since that time. In contrast, valuations today appear to present a much rosier picture in the long-term.

That "in the long-term" is the key piece! Short-term, prices could ... heck, almost certainly will fall more. As I write this, the markets are in a 3-day rally, but I expect any rally will fizzle. How low could markets go? I don't know that there is a clear answer in the data.

I would normally be tempted to answer down to the level of 14x 10-year earnings. That would suggest about 630 - quite a haircut more! But given the low level of interest rates and poor outlook for sovereign debt, I'd imagine that level seems low. I intuitively think 16x earnings is a bit high for a market bottom, and my guess is that the market will probably end up bouncing between 750-800 before a gradual rebound.

But we don't know. And at present levels, we can reasonably expect a decent return. How much? Earnings have historically grown about 6% a year. The dividend yield is about 3.2%. If we assume no multiplier change, that's still over 9% a year - a lot better than treasuries or CDs!

Shocking Compilation of the Day: Foreclosure Sales

A compilation of some shocking numbers I've come across in the last few days:

Over a third of all home sales currently are foreclosed properties! Translation: Any increase in home sales ("we have a bottom") is because of the glut of cheap homes.

23% of all homeowners with a mortgage owe more on their mortgage than their house is worth. Translation: Holy Shit!!

A foreclosure near your home depresses the value of your home from somewhere between $5,000 to over $20,000, depending on who did the study! Translation: This foreclosure thing does affect you, at least in the short-term.

Story of the Day: Fart Research!!

So evidentally the foul odor in farts has an important physiological role in controlling blood pressure. Oh dear! Please don't take this as an invitation to share. If you must regulate your BP, please find the restroom nearest you!!

There are No Tax Benefits to Owning a House for Most People!!

I was having tea with this elderly British couple from Canada today, and in between a spirited political discussion, the topic of home ownership came up. I was fascinated to learn that home ownership in Canada was a very different beast! Buyers are typically required to put 25% down (compared with actually getting cash here in the US), and most families pay their loans off in 10-15 years. This couple in fact paid their Canadian house in 6 years!! That's a stunning difference from the US.

The big difference is that there is no tax deduction for mortgage interest in Canada. That of course, is much touted for being a reason to buy a house. Save on the taxes. But that is a totally bogus reason for many homeowners.

Let's run the numbers. Using this calculator, I estimate my tax savings on a mortgage of $200,000 is just a bit over $5,000. Wow! Except that the standard deduction for 2008 is $5,450 for singles, $10,900 for couples filing jointly. Which means, you'd still elect to use the standard deduction, unless you have substantial other deductions.

And mind you, those tax savings were only for the first year - they diminish every year as more of your mortgage goes towards principal. Oh, and don't forget property taxes which can take a bit out of your wallet.

There might be many reasons to buy a house, but saving on taxes isn't one of them ...

Quote of the Day: Joe the Plumber

Joe "the Plumber" Wurzelbacher, the man in the spotlight during the third presidential debate had this to say to ABC News:

You know, me or -- you know, Bill Gates, I don't care who you are. If you worked for it, if it was your idea, and you implemented it, it's not right for someone to decide you made too much."

Here is the whole story.

Hold On!

Right when I started to get optimistic on stock market prospects, we have a fast and furious rally. The Dow ended up 11%, the S&P 11.5%, the DAX over 11%. And at the time of this writing, the Nikkei is up over 12%, and much of Asia is up over 5%. Oh well! The market might be getting ahead of itself. After all, much of the pain is yet to hit Main Street, and it's likely that when this fact sinks in, markets will fall again. It's likely we will see some weakness during which to enter the market.

Breathe Breathe ...

With the market turmoil, you may have no doubt lost a few months (years?) of your life fretting about your returns. I consider myself a value investor, who is supposed to live for times like this when assets can be purchased at a bargain, but for all that, I've had some heartburn as I've lost as much as 60% on some aggressive mutual funds, and close to 40% on an actively managed (by me) portfolio. But it is a good time to step back and take a look at the bigger picture.

I ran some computer models yesterday, and the risk/return profile has improved considerably due to the recent decline. I hesitate to provide too much information here, because much of it requires qualifiers. I have considered writing a newsletter of sorts, and even wondered if there might be a market for me to sell it at some nominal cost, not as a get-rich scheme, but to incentivize me to develop these ideas further. (Would you buy such a newsletter that focuses on the true investors, and doesn't spit out the same cliches that every mutual fund company does?)

But without getting into specifics, the expected returns from stock investing have moved from "not too much better than savings" a year ago, to offering decent (although not get rich quick) returns. We have no idea what stocks will do from here on - they could fall 5%, 10%, 50%. But that's the wrong question to ask for most investors.

It is also the first time in a while that one of my models suggests a 100% stock stake in my 401k. What? I was not 100% stocks before, even though I have over 30 years to retire? Ah, that's where the conventional advice doled out fails small investors. But that's a story for another day (or a newsletter?)

Now is a time to be a net buyer. I personally will be looking to deploy my (unfortunately very limited) funds in the next 2-3 months. In my own 401k, I have eliminated my future bond allocations and readjusted my allocation to be more aggressive.

Zogby Poll Mechanics

If you are a politics buff like me, or get your news from the Drudge Report, you probably closely follow the Zogby tracking poll, along with other such polls (the Gallup is the one featured most often). But today I saw a sentence in your release that made me say Whoa!!

The telephone tracking poll shows neither candidate with a clear advantage in the national horserace

What are the magic words? Telephone tracking poll. News flash! Telephone tracking polls don't work! One, you only select voters with phones, bias the samples for people who stay at home during the day or answer the phone ... it's very poor science! And polling is a science!


In this season of statistics, I'd like to recommend one of the best books you can read. The 1954 classic, How to Lie with Statistics is a fantastic guide for the layperson on ways companies and politicians distort statistics to make their case. And no, you don't have to be math-savvy to understand the book! In fact, the telephone poll analysis was something I read in that book years ago.

Liquidity ok, but What About Capital?

The folks at First Pacific Advisors (FPA Funds) have a brilliant new commentary (actually a week and a half old) that's a must read. They point out, much as John Hussman and others have, that the bailout does nothing to address the capital needs of banks. Unless the government overpays for distressed assets, the bailout plan will have them traded, but in some cases, may even cause banks to fail to meet capital requirements after the asset sale, causing more bank failures.

An interesting factoid: corporate America has more than $600 billion cash on its books. Allowing companies like Wal-Mart into the banking business would allow that cash to come to the rescue of our financial system.

Read the whole article!

PS: One of my favorite mutual funds, one that I own personally is the FPA Crescent Fund (ticker: FPACX). If you have some money to put away, even as little as $100 a month, I encourage you to consider this fine conservative fund which has only lost money one year since 1995!!

BW Asia Stories Galore

Wow, I've never found so many stories on BusinessWeek's Asia Insider to be quite so interesting! At a time when the US and Europe are experiencing a serious cash crunch, it seems Asia is swimming in cash. That means we could see Asian companies invest more in the US, and that includes major investments by the Indians, including, fascinatingly, in old-world industries like steel (whoever said the US steel industry was dead?)

And now the big topic of discussion is if China can save the world. The Chinese economy is slowing, property prices are falling, stocks are down 60% and more bad news. But GDP is still expected to grow at over 7%, so that holds hope of a robust Chinese economy preventing a global slowdown?

An Obvious Conflict of Interest

I like Gwen Ifill. I think she's a sharp, smart journo, and I have felt that if CBS truly wanted to get a solid woman anchor, they should have picked her rather than Katie Couric. Having said that, I was shocked to learn of her latest conflict of interest when it comes to moderating the VP debates - she's writing a book on Obama to be released on inaugration day. That means an Obama victory could make a difference of a half million dollars or more!!

I don't think Ifill will be biased, but the appearance of conflict has potentially polluted what should be an interesting debate.

Goodbye Bailout!

Ok, so the bailout isn't truely dead. In fact, it's a given some version will pass. And maybe something needs to be done. It's just this version was phenomenally vague in its specifics, and looked like it could dramatically alter the nature of American capitalism. Oh yeah, and raise the national debt while we are at it.

My objection isn't simply an economic one, although that is a valid point. The brilliant John Hussman wrote a wonderful piece titled You Can't Rescue the Financial System if You Can't Read a Balance Sheet, explaining why this does little to improve bank balance sheets and the likelihood they will fail.

My objection isn't even centrally the price tag, although $700 billion is enough to make you gasp for air. That works out to $5,072 per taxpayer in the US to buy distressed assets and flip them.

What I really dislike is that Uncle Sam would actually own the debt and potentially the stock of American companies. YUCK! For how long? What would the process be to unload these investments? As someone in most developing countries will attest, once the feds take a stake, privatization is not simple. That means we could see a landscape where we have companies with substantial governmental ownership in the US of A!

When the government maintains ownership, even if it is a modest minority stake, how does that influence government policy? As anyone with concerns about US beef will attest, the dual role of the US Dept of Agriculture in regulating and marketing beef often raises questions about the regulatory environment. On the other hand, government ownership could result in politicians trying to twist arms of the corporate leaders for political gains.

And how does the process of government divesture work? If the government sells, would it be perceived as a vote of no-confidence? What might be the rumblings of that? The government is no ordinary trader.

The stock markets have to fall. Earnings have been inflated by artificial methods and will have to normalize. But to save the taxpayer some, the Feds would do better to put a temporary hold on the 'mark-to-market' accounting rule, so they can look into other methods of valuation. 'Mark-to-model' was always bad, especially if there was no regulatory control of the model, but this mark-to-market nonsense is just as bad. Just because someone claims your house is worth $100,000 doesn't mean it is! There is a cash flow stream that has a value - maybe the accounting boards just need to firm up the assumptions used in their DCF model.

Meanwhile I won't hold my breath that another phenomenally bad bill doesn't emerge. All I hope is that the House Republicans managed to prevent the socialization of America! (Senate Repubs, way to show spine!)

Villain of the Day: The SEC?

A lot has been made of John McCain's statement that SEC chairman Cox should be fired. I thought it was a silly demand - after all, a lot of what happened is not Cox's fault. Until I saw this, from the Maudlin newsletter:

It is going to cost the taxpayers a lot of money. While I think the losses on AIG will be rather minor in the grand scheme of things, if you add up Fannie and Freddie and a new RTC, coupled with the stimulus package, you can easily get to $500 billion, and that is probably a low number. For such a price, we had better get a new regulatory scheme which requires reduced leverage. Want to get really mad? Up until 2003, all investment banks were allowed only 12 to 1 leverage. Then in 2004, the SEC basically gave five banks (and only five banks) the ability to lever up 30 or even 40 to 1. Bet you can guess the five banks. Bear, Lehman, Merrill, Morgan and Goldman. Three down.

Hmmm.

Chart of the Day: Commercial Paper

From John Maudlin, here's why the panic - the commercial paper market is what runs the economy!

Quote of the Day: Mark to Market

If you don't follow these things, a lot of the present financial crisis comes from a change in accounting rules! Seriously! The FASB changed from a "mark-to-model" approach, where companies could value financial instruments such as mortgage-backed securities using a computer model based on default rates, to "mark-to-market", which is the price you'd get in the open market, based on the last sale of that asset. John Maudlin writes:

The current mark to market rule, while nice in theory, works in normal times. But it has the unintended consequence of making things worse in crisis times. Why should an institution have to write down a security which over time is going to pay back the lion's share or more of its value just because a severely stressed institution was forced to sell that security at a very low price in a time of crisis?

Yes, there needs to be transparency and we as investors need to know what is on the books of the companies that we invest in. But it is somewhat like my bank asking me to mark to market my home and pricing my loan daily based on that new price. If my neighbor loses his job and sells his home at auction, does that mean my home is now worth less two years from now. Maybe an even better analogy, if I am renting that home to a very good tenant, does my neighbor's price impair my income?