Bernanke Campaigns for Reappointment

Good Evening: Stocks were poised to correct their recent gains today, but a late rally extended the winning streak for both the Dow and NASDAQ to seven straight. The earnings news was deemed positive by market participants, though the bottom line “beats” came even as top line revenue estimates fell short. Cost cutting can always flatter the profit figures in the short run, but mass layoffs, deferred capital expenditures, and jiggered tax rates are not what creates either prosperity or long term wealth. Perhaps business executives are taking these actions in the hope the Fed’s aggressive monetary policies can restart the economy, save their careers, and prevent their stock options from expiring worthless, but Mr. Bernanke himself is fighting for his job these days.

With no economic releases on tap today, our index futures markets relied upon earnings releases to guide trading prior to the open in New York. Caterpillar, Texas Instruments, DuPont, UnitedHealth, and Freeport-McMoran all reported positive surprises to one degree or another, though most required financial gymnastics to achieve these “beats”. For all but FCX, revenues came in on the light side. Such a divergence between revenue and profits will be hard to sustain, but who knows? IBM has been managing to pull off this same trick for years, and investors have rarely put the stock in the penalty box for it.

CIT has certainly been penalized of late, though, and today brought word the company’s privately funded recap is in doubt (see below). Reported as a virtual certainty only yesterday, the deal looked less than done today. Fresh concerns about CIT helped cause the stock market to retrace its opening gains of 0.5% or so. CAT helped the Dow remain aloft, but the rest of the tape fell in for a bit of profit taking. Most of the major averages were down some 1% at mid day when stocks began to recover. Acting as if few investors wanted to be short ahead of Apple’s earnings release this evening, the whole tape healed by the time the closing bell rang.

The Dow’s 0.75% gain led the way, while the Dow Transports lagged with a loss of equal measure. Treasurys were on the strong side, with yields falling between 6 and 12 bps. The yield on the benchmark 10 year note is now once again below 3.5%. The dollar was on the lethargic side, with smallish early losses giving way to smallish gains later in the day. Commodities followed stocks to the downside early on, but, unlike equities, they never really recovered. Pulled down by losses in the grain complex, the CRB index gave back 0.5% on Tuesday.

The 2010 campaign season kicked off today, and I’m not referring to the folks in Congress who constantly seem to be running for office. No, the race for high office I refer to is the one for the Chairmanship of the Federal Reserve System. Ben Bernanke may occupy the corner office in the Eccles building right now, but others covet his job. Perhaps sensing the brewing competition, Chairman Bernanke fired off a pre-emptive salvo in the press prior to his semi-annual testimony on monetary policy before Congress today (see below). He wanted to reassure long bond investors that, cross his heart, the Fed would tighten policy at the “appropriate time”. Not content that politicians can read, the Chairman then trudged to the Hill and took to the microphone. He tried to strike a balance between caution (downside risks remain) and optimism (tentative signs of recovery). He even tried to claim his share of credit for the receding financial crisis.

“Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial system,” he said. “Many of the improvements in financial conditions can be traced, in part, to policy actions taken by the Federal Reserve.” (source: Bernanke testimony before Congress)

Unmentioned, of course, was the Fed’s role (mostly under Greenspan) in fostering the credit bubble that later froze the credit markets, but Mr. Bernanke was not shy in saying the Fed’s monetary blowtorches were responsible for the thaw now under way. For this professorial man to strut, even a little, in front of elected officials and the media must mean he feels his job is on the line. As a Bush appointee, Bernanke knows he represents anything but the type of change promised by the Obama administration.

Bernanke knows who wants the keys to his office, too. One is Janet Yellen, and another is Larry Summers. I have no great love for Mr. Bernanke, but it’s probably fair to say that his tenure at the Fed has been marked more by trying to clean up messes than it has been marred by creating them. Neither of his main contenders can make such a claim; if anything, they’ve been part of the problem. Summers would be an especially poor choice, since he would be viewed as politicizing the Fed. Knowing that Bernanke would be on the Hill today, for example, Summers took the airwaves in a thinly veiled attempt to stay relevant (see below).

As the junior member of the famous troika on the late ’90’s Time Magazine cover, “The Committee to Save the World”, Summers is the only one of the three not (as yet) to have scorn heaped upon him. Greenspan has been unmasked as a disgrace, and Citigroup shareholders silently curse Rubin for his poor stewardship. I guess Summers wants his friend, President Obama, to give him a shot at redemption after some of his policies as Treasury Secretary under Clinton came a cropper during the credit crackup. Summers would be anything but “change we can believe in”, but his appointment would have some redeeming value. It would allow him to join the other “Committee to Save the World” members in validating the Time Magazine cover jinx. What happened to Greenspan, Rubin, and, to some extent, Summers after that cover came out is a fitting reminder that when someone tells you they want to save the world, just politely turn them down. History is littered with examples of well meaning people who did a lot of damage to the world in the name of saving it.

– Jack McHugh

U.S. Stocks Advance on Caterpillar Earnings, Bernanke Remarks
CIT Expects Loss of $1.5 Billion, May Seek Bankruptcy
The Fed’s Exit Strategy, by Ben Bernanke
Summers Urges Banks to Lend More, Says Growth Pace ‘in Doubt’

Tuesday Linkage

Tuesday linkage  — something for everyone:

•  Bernanke Disarms Lawmakers With Garage Meetings, Credit Repairs (Bloomberg) see also Bernanke Heads to Congress Battling Calls to Tame the Fed (WSJ)

Are Manufacturers Also Too Big to Fail? (NYT)

At N.Y. Fed, Blending In Is Part of the Job: Some Fear Wall Street Too Heavily Influences The Financial Enforcer  (Washington Post)

Why Japan Isn’t Rising (Newsweek)

Distressed Assets Market and FDIC Closures (Real Property Alpha)

Morgan Stanley’s Albatross: Real Estate (WSJ)

Bailout Overseer Says Banks Misused TARP Funds (Washington Post)• Is Something Wrong with Certain Kinds of Trading? (Cassandra Does Tokyo)

Patternicity: Finding Meaningful Patterns in Meaningless Noise (Scientific American)

Yahoo to Launch New Homepage (WSJ)

10 Worst Evolutionary Designs (Wired)

Why did I miss — anything linkworthy?

Off to Vancouver


I am on my way to the Agora Financial Investment Symposium, where I will be one of the keynote speakers (along with Boom Doom and Gloom’s Marc Faber, BIll Bonner and Addison Wiggins.

I will be doing both a keynote speech Wednesday morning, and a Bailout Nation discussion later that day.

If you are in the Vancouver area, swing by and say hello!

Bulls Win Today; Watson’s Example is Timeless

Good Evening: U.S. stocks stretched their recent winning streak to six straight today, as some good economic news and some potential help for CIT combined to lift share prices. With more investors becoming convinced the worst is over for our economy, the major averages all tacked on gains of 1% or more. The S&P 500 posted its highest close of 2009 on Monday, and though we haven’t exactly seen a buying panic yet, those who are either short or underinvested are getting increasingly uncomfortable. The swelling ardor for equities should remind bulls and bears alike of the need to be patient and flexible in this unprecedented environment, but I wonder if we would even be in this fix if financial professionals at all levels were more like Tom Watson.

Stock markets overseas were on the firm side overnight, as were our stock index futures this morning. Much of the credit for this early rise went to a pending capital infusion by CIT’s current bondholders (see below). This privately financed rescue package would be a costly one for CIT (indications are LIBOR +1000 bps), but it’s good news in that 1) hundreds of small and medium sized businesses will see less disruption to their operations, and 2) the U.S. government is not involved. With $2 billion out of a total of $3 billion already committed, a CIT rescue is not exactly a done deal, but word that Seth Klarman’s Baupost Group is on board will probably give other bondholders the comfort (and cover) they need to participate.

Adding to the warm and fuzzy feelings before the bell was a stronger than expected print for the leading economic indicators. Up 0.7% versus consensus estimates of 0.5%, the leading indicators figures have now been strongly positive for three straight months — a streak usually associated with the end of recessions in the post WWII period. This post-bubble recession may be a different animal than ones populating econometric models, but the strength in the LEI was enough to cause BAC-MER to once again opine that the worst is most assuredly over for the U.S. economy (see report at bottom). Other firms offered similar sentiments, and stocks wasted little time in rallying 1% once trading commenced in New York.

When the S&P was unable to surmount the 950 level, a quick bout of profit taking took the major averages back toward unchanged. That was it for the downside, though, and equities spent the balance of the session marching higher. By day’s end the S&P did manage to close above 950, and the rest of the averages closed with gains ranging from 1.1% (S&P, Dow) to 2.1% (Dow Transports). Treasurys for once didn’t suffer at the hands of a strong equity tape, and yields fell between 2 and 5 basis points. Dollar holders had their pockets picked by approximately 1%, while commodities continued their confident run to the upside. Recently acting more like a tech-laden ETF than a basket of tradable goods, the CRB index levitated a further 1.2% today.

It was nerves, pure and simple. I refer not to yesterday’s British Open, but to the time 13 years ago when I stood on the first tee of the 445 yard first hole at Cog Hill Golf Club. Through a series of fortunate events, I had the honor of playing in the Pro-Am of the Western Open, one of the PGA tour’s oldest tournaments. Before I could even swing my driver on that opening hole, I had warmed up on the range with household names; I had my photo taken with a future member of golf’s Hall of Fame; and my brother/caddie was sporting a bib with my name on it. Greg Norman’s group had just teed off ahead of us, and the group including Tiger Woods, then an amateur, was set to tee off in the group behind us. The fairways were lined with people on both sides, the loudspeaker had called my name, and I suddenly realized this was a very big deal.

I barely made contact, and the ball skittered just far enough along the ground for me to escape the indignity of not getting past the ladies’ tee box. As my group headed toward the fairway, I asked our pro for advice. “Tom, how can I deal with nerves on the golf course?” The legendary Tom Watson turned to me and smiled, saying, “just take a deep breath, finish your backswing, and then fire. You’ll be fine”. And he was right; it worked.

Though he was trying to prepare for the tournament that would start the next day, Tom Watson spent the entire afternoon engaging everyone in our group. Want golf advice? He gave it. Prefer to figure it out for yourself? Tom let you play. Ask him a question, and he’d look you in the eye before giving you a straight answer. He told golf stories, a couple of jokes, and was not above playing a practical joke on one of his playing partners. Coming off the 18th green, our whole group agreed that Watson was a consummate gentleman from the old school, the type of man who understood it is the fans, volunteers, and pro-am donors who transform the game he loves into a great way to make a living. He tried very hard to make everyone — including the marshals and sign holders — feel special. He was a class act, a man of character.

I relate this vignette not because I’m a golf fanatic (though I am). Nor is it some ode to Tom Watson, though it would be fitting after watching him almost beat the world in the Open Championship this past weekend at the ripe age of 59. I write not to say how much I feel for a man who gave it his all against long odds in an attempt to make sports history. No, I write to say that I wish there were more Tom Watsons on this planet. Had the executive suites in Wall Street been populated by men with his character, and had policy makers in Washington (e.g. in the corner office of the Eccles building) possessed even a fraction of his values, then we might have avoided the worst of the financial crisis.

It’s been said, and I agree, that you learn a lot about a person during a round of golf. Honor, grace, dignity, and a penchant for doing what’s right because it’s the right thing to do — those were the things I learned about Tom Watson that day in 1996. That he couldn’t win a record sixth British Open when almost eligible for Social Security is a shame, but it’s not a tragedy. As Mr. Watson himself said in mock admonishment to the press after letting the title slip away in a playoff yesterday, “C’mon, this isn’t a funeral!” No, the tragic loss I bemoan is that there aren’t more people like him, and not just on the PGA tour. Whether in high places in Wall Street or in high office in Washington, we need more role models like Tom Watson.

– Jack McHugh

U.S. Stocks Gain, S&P 500 Jumps to Highest Level Since November
CIT Said to Get $3 Billion Rescue Financing From Bondholders
Leading Index Shows U.S. Economy Nearing Slump’s End
Tom Watson Not Ready to Mourn After British Open Loss to Cink
LEI suggest economy passed the bottom.pdf

Is Goldman just a credit punt?

The Big Picture suggests that it might be, and provides this initially compelling illustration (which I have edited slightly to make it less confusing). However, I think that what we are really seeing is that both overall credit spreads and Goldman's stock price are driven by confidence. The more economic activity there is, the more money Goldman can make from the flow. A similar phenomenon was observable with the Merrill stock price in the 90s -- it acted like a call on the S&P, for similar reasons.

Update. Given ...the furore about Goldman's continued use of a SEC rather than FED VAR calculation, despite being a bank holding company, I am driven to wonder how big Goldie's IRC is. If it is just a giant credit punt, one might expect it to be enormous...

Minsky, mortgages and you

In practice:

Minksy’s protracted moment

If you follow this blog, you’ll recognise these names: Jeremy Grantham, Nouriel Roubini, Robert Shiller, and James Montier. I’ve quoted them many times, and they anticipated the financial crisis.

They have something else in common, they’re all followers of economist Hyman Minsky. Grantham describes himself as a Minsky maven. Roubini  feared we were at the top of Minsky credit cycle in July 2007. There’s an intellectual genealogy linking John Maynard Keynes to Robert Shiller via Charles Kindleberger, Shiller’s teacher, and Minsky, who influenced Shiller. James Montier describes himself as a proponent of the Kindleberger/Minsky framework for analysing bubbles.

Montier recently left Soc Gen, for GMO, Jeremy Grantham’s company. It’s a small, Minskyish club of financial crisis Cassandras.

Here’s Montier’s Kindleberger/Minsky crib-sheet showing the phases of bubbles and crises current and past (click on it for the full sized version):


There are at least five phases, and no prizes for spotting we’re in either phase four or phase five now:

  1. Displacement: A new development, the Internet say, or low interest rates, creates investment opportunities.
  2. Credit creation: Banks create credit to fund the boom, new banks form, and invent new ways of lending and borrowing.
  3. Euphoria: As stockmarket prices rise, overconfident investors ignore risks, abandon safeguards, and make bad  investments.
  4. Distress: Insiders cash out, the prices of investments start to fall and some prove to be fraudulent.
  5. Revulsion: Investors can no longer bring themselves to participate in the market. Investments are cheap again.

Minsky, who died in 1996, explained the credit cycle which fuels booms and busts.  In his Financial Instability Hypothesis (for a nutshell explanation see CXO Advisory Blog) he said the economies are not self-correcting, or equilibrium-seeking, as is commonly supposed, but, depending on the nature of borrowing and lending, can be wild and unstable.

According to the FIH there doesn’t need to be any reason for a recession, or a depression, beyond a long period of prosperity, which lulls borrowers, investors and regulators into complacency, a situation which seems to describe the year 2007.

As confidence in the status quo grows the kind of debt used to finance investment and consumption changes from:

  1. Hedge financing where the borrower can repay the debt out of income and has a high equity stake, to…
  2. Speculative financing where the borrower can repay interest but not the loan, which must be refinanced when it’s due, to…
  3. Ponzi financing: where the borrower cannot repay interest or the loan but must sell assets or borrow more to meet its commitments.

When hedge financing dominates, the economy is stable. When the other two categories dominate, it’s not. Ever-riskier borrowing leads to financial bubbles, and when confidence bursts Ponzi and speculative borrowers are unable to refinance. Instead they must sell assets to stay afloat, driving markets downwards and squeezing more borrowers.

In a recent paper Paul McCulley, managing director of Pimco the giant American asset manager, explains how this time a shadow banking system, unregulated investment banks, hedge funds and the now notorious structured investment vehicles, created explosive growth in debt which ratings agencies and regulators were ill equipped to deal with because they simply hadn’t seen this kind of debt before (and the rating agencies were in the pockets of the shadow bankers).

Since Minsky first published his theory in 1986, McCulley says:

…the first thing we do when we discuss Prof. Minsky is show reverence.

Chalk up another acolyte, who warned that interest-only and subprime mortgages are textbook examples of speculative and Ponzi finance in March 2007.

For a graphic, and somewhat easier to absorb illustration, you only had to watch Freefall on BBC 2 on Tuesday night (you still can on iplayer), and judging by the reviews on, Robert Barbera has written an excellent explanation in his book The Cost of Capitalism.

Freefall dramatised the human side of what McCulley calls the Minsky Moment, or the bursting of the bubble.

He coined the term to describe the Asian credit crisis of 1997, when it was Asian corporations doing the risky borrowing, but the pattern repeats itself through history, as Montier’s crib-sheet shows.

It’s apparent now that nearly everybody’s carried away by these credit fuelled business cycles, from the commanders of the economy, like Alan Greenspan and Gordon Brown, to the family that borrows more than it can afford, reassured by rising house prices.

But this chart, which accompanied an article in Der Spiegel about another economist, William White, who also warned of the impending crisis, makes me wonder whether we have reached revulsion, the final phase of the cycle, yet.

Grafik CS4

Although it refers to America, the UK’s had nigh-on thirty years of falling interest rates too, which probably makes us very complacent.

Figures from the Council of Mortgage Lenders show that the number of new and probably speculative interest only mortgages have declined from a high of about 34% of house purchases in 2007 to 19% in May, but 26% of remortgages are interest only.

More worrying, I think, is borrowers’ predilection for short-term fixed-rate deals and lenders’ willingness to supply them. The CML doesn’t have statistics for the relative popularity of short and long-term fixes but says that one to three year deals are by far the most popular.

The nation’s gambling that interest rates when we come off those rates will remain low. I’m not sure where these deals sit in Minsky’s scheme, but they look speculative.

Add in more risks; house prices falling further, lenders unwilling or unable to refinance loans on similar terms, unemployment, and mortgage holders enjoying low rates now on mortgages that aren’t fixed for the long-term face an incalculable future.

Borrowers haven’t yet learned Minsky’s lesson. Don’t even get me started on bankers!


Have asset prices further to fall? The economy is distressed, but there’s a big difference between phase four of the cycle (distress) and phase five (revulsion). In phase four asset prices are still falling and in phase five they’re cheap.

My modest contribution to the study of asset prices, measuring the long-term price earnings ratio of UK shares, shows they are cheapish but not necessarily revoltingly so.

And just to add even more ambiguity to that statement, Robert Shiller, who believes that lower long-term price earnings ratios do predict higher returns, says the precarious state of the economy means stockmarket predictions are even more unreliable than usual.

In theory:

Vampire Squid is a buy

Some more economists who know what they are talking about. This time Alphaville highlights research by Dirk J Bezemer, including a list of analysts ‘who saw it coming’. Contrary to main stream economists, these analysts paid a great deal of attention to the role of finance and property in the economy.

Another one, Nassim Nicholas Taleb, says instead of inflating assets, banks need to deflate debt by offering homeowners lower interest rates for part ownership of their property.

Pimco’s Paul McCulley, pulls out Ben Bernanke’s roadmap, and sees Washington cutting taxes and printing money like never before.

Meanwhile, the Federal Reserve Bank of New York has published two timelines showing what governments have done so far.

Jeremy Siegel: “Stocks always win in the long run”. Barry Ritholz says “No!”

Meredith Whitney, an analyst that was bearish on banks before the financial crisis, issued a buy note on Goldman Sachs, aka ‘The Great Vampire Squid’.

Ric Traynor, of restructuring specialists Begbies Traynor, says corporate insolvencies could exceed peak levels at the height of the last recession in 1992. They’re up 43% year-on-year.

Graeme defines a value trap.

If financial comment isn’t free, it isn’t influential says Felix Salmon.

Bernard Madoff is transferred to the same prison Charles Ponzi was jailed in.

The world’s least favourite airline

I'm still digesting the proposed changes to IAS 39 and to Basel 2 (you wait two years for major accounting and regulatory change then two of them come along at one), so for now I'll just quote a delightful Luke Johnson column in the FT. I read it on a plane, and I agree with this wholeheartedly:
BA has become an institution run not for the benefit of its customers – who provide its revenue – but for its staff and pensioners. Its shareholders, meanwhile, have long been forgotten.
If a firm like BA isn't a conviction short, I don't know what is.

Reality and perception in equity markets

The hard part about making market calls is not coming to a view on fundamental value. While that's difficult, it is still easier than the other part of making a trading decision, which is estimating current and future sentiment. It's particularly tricky at the moment: fundamentals suggest to me that most developed equity markets are over-valued. But sentiment is positive, and there is a wall of money still sitting nervously on the sidelines. If even a small fraction of that comes to the market, we could go significantly higher. The greater fool trade is always risky, so I'm flat equity at the moment and likely to remain so at least until either fundamentals improve or sentiment (and prices) turn down. Just my two cents: I wouldn't pay any attention if I were you.

Thrifty 30 progress report

In practice:

Good companies at cheap prices

Thrifty30 Occasionally on Twitter investors, as opposed to people hawking porn sites, show interest in my tweets. So, when henrio83 asked ‘What’s happened to your thrifty thirty?’ I thought I should explain.

First, a quick recap.

Thrifty 30 is the name I gave a method of discovering good companies at cheap prices. It’s based on the ideas of Benjamin Graham, the long-dead father of value investing, who recognised the main risks facing investors are paying too much for shares and investing in financially weak companies and declining businesses.

Towards the end of his life he proposed a system that any investor could follow, which involved buying shares costing less than seven to ten times their latest profits, measured by earnings per share, in companies that own more than twice what they owe.

By avoiding the riskiest companies Graham figured he’d do well.

The correct PE ratio depended on bond yields, and investors could calculate a company’s financial strength by comparing its shareholders’ equity to its total assets. If equity was at least half of the company’s assets (what it owns) then its liabilities (what it owes) must be less than half.

As now, newspapers reported PE ratios and investors could easily find a company’s equity and assets in its annual report.

The system is thrifty because the companies are cheap, and not overly indebted and thirty because, for safety’s sake,  Benjamin Graham advocated holding twenty, or preferably thirty, companies in a portfolio.

If that sounds like gobbledegook you can read my fuller explanation.

Last March I constructed two Thrifty 30 portfolios, one for Interactive Investor and one for Money Observer (PDF). I haven’t tracked their performance, although considering the stockmarket recovery I’d probably look like a genius if I did. That conclusion would be misleading for all sorts of reasons, but even it were true three months is not enough to judge a system promising 15% returns over five years or more.

I’ve been running a slightly longer but less rigorous test in the Share Sleuth column, also published in Money Observer. All but one of the companies I’ve featured in its first year have done OK, and three, EDI, Carluccio’s and ITE met or exceeded Graham’s 50% profit target very quickly. The only failure, so far, is Optare which, coincidentally is the only one that didn’t meet my Thrifty Thirty criteria. However, it’s also too early to judge Share Sleuth and the title of the latest column describing the first year of Share Sleuth ‘Triumph over adversity’ sets me up nicely for a slice of humble pie next year.

Since March I’ve been working out how to improve on Graham. That’s sacrilege of course. Graham is the pre-eminent value investor who invented the discipline, wrote the textbook, and inspired greats like Warren Buffett.

These days, with more data available to the private investor, it’s possible to substitute the long-term PE ratio, an invention of Graham’s by the way, for the one-year historical PE ratio and Piotroski’s F_Score for Graham’s measure of financial strength. Both measures have more potential, I think, judging from the academic research and are a good basis for reducing the market to a manageable number of Thrifty 30 candidates.

Most of the companies I’ve reviewed on the blog since March have met these criteria, and many of them, as long as they are still cheap enough, will feature in a new Thrifty 30 portfolio that I will compile and maintain when I get back from holiday in August.

And that, really, is the mission of this blog:

  • To understand the stockmarket and how to profit from it, as I do in the posts categorised ‘markets’ and ‘investing’.
  • To identify good companies at cheap prices, as I do in the ‘companies’ category.

All that’s missing is to prove it works, by:

  • Running a model portfolio that earns market-beating positive real returns over every five year period of this experiment

Which is coming soon. Meanwhile, here are some companies that have financial year-ends in the last six months and currently meet my Thrifty 30 criteria:

Ggearing is Grahams original measure of financial strength, which I still keep an eye on, and EPS count is the number of years of earnings data used in the long-term PE calculation.

I derive the figures from data from and Sharescope. Readers interested in recreating Graham’s original screen can do it using the Sharelockholmes website (it charges a small monthly fee).

Here’s the long-term PE ratio for the whole UK market:

As you can see it’s stuck on 11, which looks cheap, but Jim, a reader from the United States sent me an email yesterday warning of complacency:

The following post links to an Excel spreadsheet that has a 10-year PE for the S&P 500 going back over a century… The data there shows that the average 10 year PE for the market over more than a century is just over 16. But it also shows that there are very long periods of time when the 10 year PE was quite depressed. For 10 years from 1915 to 1924 the average 10-year PE was just below 8 or less than half the long-term average. That’s quite a long time for stocks to be so dramatically cheap. For another 10 years from 1975 to 1984 the 10-year PE averaged less than 9.5. And of course there is the aftermath of the Great Depression: for 20 years from 1931 to 1950 the average 10-year PE was under 12.8. That’s forty years overall where the long-term PE was at *least* 20% below the century average, and sometimes over 50% below it. The low PE during the 70s and 80s is really not that long ago, and it was quite far below the average. To know that stocks may trade below 10 times their 10-year average earnings for a decade makes one hesitant to buy the market as a whole based on PE alone.

The Thrifty 30 isn’t an investment in the whole market, it’s an investment in the undervalued part of it. But you have been warned!

In theory:

The economy according to Clarkson

Add Jeremy Clarkson to my list of economists who know what they were talking about.

Nick Train, is the UK’s Warren Buffett, says the Investors Chronicle, but it doesn’t mention whether he measures up, in terms of performance.

George Soros: “When I see a bubble, the first thing I do is buy

Fixing monopolies

The monopolies and mergers commission has proved utterly ineffective in dealing with the large supermarkets. Tesco, in particular, plays far too large a part in the total UK shopping spend. They are a malign influence. So what can we do? With a bit of luck, we can get two birds with one stone, and cripple them by making them over pay for Northern Rock. If they can somehow me coerced into taking a few toxic bits of Lloyds too perhaps that will shut Neelie Kroes up too...

Deficient Markets Hypothesis

In theory:

As dead as a parrot

In his latest note, Soc Gen Analyst James Montier, compares the efficient markets hypothesis (EMH) to Monty Python’s dead parrot.

No matter how much you point out that it is dead, the believers just respond that it is simply resting!

Montier’s often pronounced EMH dead. In fact, he’s getting so frustrated he’s beginning to rant like John Cleese.

The shopkeeper refusing to accept EMH’s demise could be arch-exponent Burton Malkiel whose book, A Random Walk Down Wall Street is an investment classic now in its ninth (2007) edition. Malkiel, a professor of economics, and investor says the premise of his first edition, that:

…the market prices stocks so efficiently that a blindfolded chimpanzee throwing darts at the Wall Street Journal can select a portfolio that performs as well as those managed by the experts…

…has held up pretty well:

More than two-thirds of professional portfolio managers have been outperformed by the unmanaged S&P 500 Index. Nevertheless, there are still both academics and practitioners who doubt the validity of the theory.

Those of us who try and beat the market have a case to answer:

First, there’s an elegant and simple theory that states that if people behave rationally then they will pay more for good investments, right up until the point they are no better value than lower quality but cheaper investments. In such a world, the price would always be right and there would be no reason to invest in one company, over another. Catch-22.

Second, most investors who try to beat the market, fail.

I can almost hear Montier screaming. As I said last week, an alternative hypothesis, beloved of value investors and the emerging field of behavioural finance, is that investors aren’t rational. They herd, finding safety in numbers and bull markets, right up until they go off the edge of the cliff together in bear markets.

If you invest in the market through index trackers as Malkiel advocates, you’re tied into that daft behaviour. But judging by their records, the professional investors Malkiel talks about, make even dafter choices.

How can that be? Another academic, Mark Rubenstein, described the sub-par performance of professionally managed funds as:

…a nuclear bomb against their [the behaviouralists’] puny sticks… [they] have nothing in their arsenal to match it.

Montier says this observation is flawed because US institutional investors managed about 70% of the whole US stockmarket in 2007 and the composition of their portfolios mirror the whole market. Hence they’re doomed, as a group, to be average, or below average after they take their fees. In other words, they’re not as independent of the market as they’d like us to think they are.

Why should that be? Career risk, he says, explains the herding. To bet against the market is to stand out from the crowd. When, for a while, you do worse than the market, you stand out for the wrong reason. Clients withdraw their money and you risk going out of business before you demonstrate you can beat the market. As John Maynard Keynes said:

…it is better for reputation to fail conventionally than to succeed unconventionally

So professional investors are very rational. They do what it takes to keep their jobs, even if those actions don’t serve the long-term interests of their irrational clients, pension fund trustees, insurance companies, financial advisers, and, well, people.

If EMH is dying, Montier is doing his best to ease it into the coffin. He quotes a survey showing 67% of chartered financial analysts thought the marked failed to behave rationally:

When a journalist asked me what I thought of this, I simply said “About bloody time”. However, 76% said that behavioural finance wasn’t yet sufficiently robust to replace modern portfolio theory (MPT) as the basis of investment thought. This is, of course, utter nonsense. Successful investors existed long before EMH and MPT. Indeed, the vast majority of successful long-term investors are value investors who reject pretty much all the precepts of EMH and MPT.

Now read this :-)

But does it matter, beyond, the arcane arguments of academics and investors? Well, yes. If markets are irrational, then it’s adherents of EMH that have a case to answer, says Philip Coggan, The Economist’s Buttonwood columnist:

From this [the assumption that market prices are always right] developed the idea that bubbles cannot exist and thus that central banks should do nothing about rising asset prices. That belief may well have been dangerous. In particular, returns are not “normal”, in the sense of following a bell curve distribution. They are plagued by fat tails or extreme outcomes; failing to allow for these outcomes contributed to the recent crisis.


If the stockmarket was efficient, then computer algorithms would be better at trading than humans, says quantitative trading system designer Joshua Holden.

Seth Klarman explains the market’s short-termism. Fund managers who focus on long-term wealth creation should be rewarded but it’s actually those that do well in the short-term that get assets.

The Economist reviews “The Myth of the Rational Market” by Justin Fox.

Whatever next? Hedge fund managers are plugging their platforms into Twitter.

In practice:

The price isn’t right

Strictly not for EMH acolytes: The stockmarket is still looking  cheap, although it’s not in outright bargain territory as it was, briefly, in March…

…Which may explain the glut of apparently cheap and financially sound companies. All of the following have prices less than twenty times average earnings and score six or more  out of nine according to Piotroski’s F_Score:

The date as always is from two commendable services and Sharescope.

The How and Why of value investing

In practice:

It’s not science, and it’s not about rockets

HAWRocketsAndMiscles As a youngster, the “How and Why” books inspired me and I’ve just experienced overwhelming nostalgia browsing this website. I’m not alone. Definitely not alone!

How and Why books explained things, and to a boy who’s previous main source of wisdom had been the Valiant Annual, How and Why was a major step up.

So, in the spirit of How and Why, I’m going to explain How and Why I choose the companies I write about, as well as What, a list of companies that meet my criteria for investigation.

First, Why…

By going to the considerable effort of picking shares, and not, for example, settling for the slightly below average stockmarket performance promised (for minimal effort) by an index tracking fund, I’m expecting above-average returns over five or more years.

In theory, that’s very difficult to achieve because share prices are determined by people’s rational expectations. If we think a company will do well we buy the share, and its price rises. If we think a company will do badly we sell the share, and its price falls. Good companies, in other words, are expensive to own, which nullifies their attraction to investors.

In financial jargon, the stockmarket is efficient and there’s nothing to be gained by painstakingly researching shares. You might as well throw darts at the Companies and Markets pages in the Financial Times (better that than lists of companies on your computer screen).

Active investors, and, I think, the man in the street, know there’s more to share prices than rational expectations. Since the days of tulip mania, the suspicion has always been that mob-psychology is at work in financial markets. Companies, sectors and whole stockmarkets go in and out of fashion and it’s when the stockmarket is at its most inefficient, when share prices diverge from the underlying value of companies, that the stockmarket is most interesting and investing is most rewarding.

Then, investors can pay less for shares than they reckon they’re worth, and later, when the shares are popular again, they can sell them.

Successful investing isn’t about finding the best companies, its about finding the best companies at the best prices. It has a lot more in common with betting on horse racing than I like to admit, at least, if gambler Patrick Veitch, is right. Earlier in the year I heard him say something on Radio 4 that was so relevant to investing I scribbled it down:

Most people who look at horse racing are looking for something they like, something they think is good. And to win seriously at betting you’e not going for something that’s good, you’re going for something that’s underestimated.

It’s not rocket science. It’s not even, wholly, science. But that’s what makes investing so challenging. You have to spend your time in the company of unpopular shares, trying to work out which ones smell a bit, but will do well again, and which ones must be chucked out of the fridge before they kill us.

The way to do that is to put safety first…

Then, How…

…By focussing on companies that:

  1. Have long records of profitability
  2. Are financially sound
  3. Sell products and services likely to be in demand in future, and (of course) that…
  4. Are cheaper than they should be.

If that doesn’t sound like fun and you’d rather be chasing growth in China, then you’re probably not cut out to clean kitchens, or be a mortuary attendant either. It helps if you can find joy, where other’s find despondency, or a piece of yesterday’s half-eaten steak.

It’s also helpful not to have to rummage through the entire stockmarket, and I use three financial statistics to help me find likely candidates. Briefly:

  1. The Long-term price earnings ratio. This is the price compared to the company’s average profits over a minimum of five years, and preferably nine. Just like the regular price earnings ratio, a low PE is indicative of value, and higher returns in future, but the long-term PE works much better.
  2. The F_Score. A super-statistic that combines nine variables to measure a company’s financial strength. Companies with a high F_Score are profitable, have decreasing debt, and increasing liquidity. They’re unlikely to go bust and more likely to be getting out of trouble, than into it.
  3. Graham Gearing. Benjamin Graham, mentor to all value investors, liked to buy shares in companies that own more than twice what they owe (the ratio of shareholders’ equity to total assets is greater than 50%). While I’m not wedded to that ratio, I think the more liabilities a company has, the more risky it is.

The table below, calculated from data exported from Sharelockholmes and Sharescope includes companies with a long-term PE of less than twenty and F_Scores of six or more (out of nine), that have reported relatively recently.

They’re not all suitable. Stobart, the haulage company, only floated last May when it took over a listed property company. Five of the six years of profits associated with its listing, and used to calculate its price earnings ratio, are not relevant.

So I check each company’s history, its finances, its prospects, who else owns it, and write short summaries, linked in the table.


Averaging the long-term PEs of all the companies listed in London derives a long term price earnings ratio for the market. As you can see it’s halved since 2007 before staging a small recovery in recent months.

That should mean there are plenty of companies at low prices, a fact confirmed by the number appearing in the table above.

It’s a good time to be a value investor.

In theory:

When’s an ETF a structured product?

Chart porn: Two economists extrapolate the future from the past and say we’re on target for a Great Depression.

Financial bloggers are increasingly sceptical about Exchange Traded Funds, Alphaville reports.

The Empirical Finance Research Blog, uncovers research that proves the US stockmarket is inefficient.

Roger Ebert, movie critic and wise old man, decries the shouting journalists.

The indisputably brilliant Moneyterms explains how a company can be technically insolvent but carry on regardless.