The Aleph Blog

Hertz Donut

Photo Credits: Michael Gray & Brian Turner || And thanks to Pine Tools for concatenating the images

When I was in Eighth Grade, I wasn’t very popular, and in World History class, I sat behind a guy who was even less popular than me, and he was usually quite shy. Still it was my policy not to look down on anyone because I knew what it was like to be lonely, so occasionally I tried to be friendly to him.

Well, one day he came up to me and said: “Have you heard of Hertz Rent-a-Car?”

DM: “Of course.”

Guy: “Have you ever heard of a Hertz Donut?”

DM: “What’s a Hertz Donut?”

He gives me a big hit to my shoulder and exclaims “Hertz Donut?!” [To non-English speakers, the joke is that he was saying “Hurts, Don’t it?!”]

Well, as was common for many jokes with 14-year old boys, there is more energy than brains, so it was less than a week before the joke traveled around the junior high school, running out of victims, and long since bereft of humor, if there was any to start with. What surprises me now is that there is now actually a real meaning to the phrase Hertz Donut — it describes the stock of Hertz in the near future.

The stock of Hertz will, with high likelihood, go out at zero.

Start with this: the firm has filed for bankruptcy. Stockholders mostly get nothing in bankruptcy. Sometimes they might get a little new stock or some warrants to help them save face, because they are delaying the reorganization, but this is usually a trivial amount of money, and implies a big loss to the stockholders.

Second, the bond market is almost always smarter than the stock market, because it reflects the actions of institutional investors who are generally good at assessing risk. There are a large number of distressed debt investors out there, estimating what a reorganized Hertz will be worth. The senior unsecured debt is trading at $38 per $100 of principal. There is no preferred stock, and a minimal amount of second lien debt.

I don’t know all of the complexities of the asset-backed securities that they have issued, but the main physical asset of Hertz is their cars, and the cars secure most of the borrowing of Hertz, via asset-backed securities [ABS]. That means that the hard assets (cars) of Hertz are likely not available to unsecured claimants.

With the senior unsecured trading at such a large discount to par value, it seems impossible that the current stockholders would get much if anything out of a reorganization. Most of their assets are encumbered via ABS. The senior unsecured bondholders are the class of security holders that will receive partial payment, and as such, will likely be the controlling class of securities that will receive the equity in the new Hertz, while the old common stock is either cancelled, or receives some nominal allocation of securities in the new Hertz.

Thus I say to those who hold Hertz equity, sell your shares. Because of mindless speculation, the price is overly high. Take your opportunity, and sell to those who are less wise.

Now, some might ask… what are my motives in writing this? They are purely intellectual. I don’t short stock. It’s a very hard way to make money, and even if you are right, you could get caught in a severe short squeeze, and give up before the stock goes out at zero.

It is really tough to short a stock to zero. It is a “picking up nickels in front of a steamroller” type of play.

So, no, I am not long or short Hertz. Gun to the head, I would short it, rather than go long, but I would size any position to reflect the possibilities of a short squeeze. I.e., I wouldn’t short much.

Full disclosure: no positions in anything mentioned in this article

The Federal Holiday Polls via Twitter

Photo Credit: GPA Photo Archive || FIreworks over New York City — beautiful, huh?

Though my adopted children were all black to some degree, I had not heard of Juneteenth until yesterday. When I read a little more about it, and the efforts of some to make it a Federal Holiday, I thought, “Okay, if Juneteenth became a Federal Holiday, which other Federal Holiday would likely disappear?”

Now some might ask, “Why not just add another Holiday?” I don’t think there’s a free lunch there — if there is less labor, people would get paid less, and that would affect poor people more than those better off.

Anyway, that made me think of doing a Twitter poll to see what holiday people would be willing to do away with. There are ten holidays and I wanted to make sure that each section of the poll would have a “none of the above” as a possibility.

That meant doing ten little polls with randomized competition among holidays. It was a small challenge to create randomized polls that did not have repeats in the choices for any particular poll, and where none of the ten polls were identical to each other. It’s harder than it seems, but using Excel 2007 I was able to get it done in 20 minutes with aid from the lesser known goal seek command.

As you can see, one goal of the polling is to unscientifically determine the least popular holiday. There were a few more goals. I thought it would be possible that some might think that Juneteenth and the birthday of Martin Luther King Jr. cover similar topics. Would some people suggest a trade of one for the other?

Also, would “none of the above” get a lot of votes? Are people happy with the current situation? That would indirectly answer the question of how much sympathy there is for Juneteenth as a Federal Holiday.

To that end, I ask my readers if they would be willing to vote on these polls.

I think highly of my readers. I particularly appreciate the way that most of you who choose to comment at my blog are measured in your comments. I don’t have to deal with a lot of off topic or crude comments.

So, if you have a few minutes of time, go ahead and answer the polling questions. I’ll do a post with the results either tomorrow or Friday. Thanks.

PS — the polls cut off in the 2PM hour tomorrow, US Eastern Time.

Estimating Future Stock Returns, March 2020 Update

Graphic Credit: Aleph Blog, natch… same for the rest of the graphs here. Data is from the Federal Reserve and Jeremy Siegel

As I said last time, a lot can happen in 3 months. At the end of March 2020, a rally was starting that would become a new bull market. At that time, the market was poised to deliver a return over the next 10 years of 6.84%/year. As I write this evening, after the rally the likely return over the next ten years is 4.63%/year.

Hee are a few more graphs, and then I will come to my main point for this post.

25 scenarios — one down, 24 up over ten years, with an average likely return of 4.63$/year.

In general, this model fits the data well, but who can tell for the future? This is likely the best estimate over a ten-year horizon.

So, do you go for stocks here with a likely return of 4.63%/year, versus the Barclays’ Aggregate at around 2.5%/year or cash at around 0.2%/year? You can hear the siren call of TINA (There Is No Alternative) loud and clear.

Let me peel this back a bit for a moment, as one who once managed a large portfolio of bonds. Why not always buy the highest yielding bonds? The answer that would come back from the bright students would be: don’t the highest yielding bonds default more?

The bond manager that buys without question the higher yielding names presumes stability in the financial markets, and likely the economy as well. Defaults can affect the realized yield a lot. You might be getting more yield today, but will you be able to realize those yields? In addition to losses from defaults, many managers lose value during times of credit stress because they are forced to sell marginal bonds that they are no longer sure will survive at distressed prices.

I think the estimate of returns that I have given on the S&P 500 is a reasonable estimate — it’s not a yield, but an estimate of dividend yield and capital gains. 4.63%/year over 10 year certainly beats bond handily. But do you have the fortitude, balance sheet, and time horizon to realize it?

More say they have it than actually do have it. The account application form at my firm stresses the risks of investing, and talks about stock investors needing a long time horizon. I still get people who panic. The present situation, given the novelty of a virus “crowning” (idiom for a whack to the head) the market, and the market largely ignores it makes many panic, assuming that there must be a big fall coming soon.

Eh? There might be such a fall. The S&P 500 could reach a new high in July. Who cares — that is why I run a 10-year model — to take the emotion out of this. If you are afraid of the market now, you should do one of three things:

  1. Sell your stock now — you are not fit for stock investing.
  2. Sell your stock now, and choose two points where you will reinvest. What is the lower S&P 500 that would give you comfort to invest? Second, if after an amount of time the market doesn’t fall to the level that you dream of, at what date would you admit that you were wrong, and reinvest then.
  3. Do half — sell half of your risk away, moving it to safety. Again, try to set a rule for when you would reinvest.

In general, I don’t believe that there is no alternative to stocks, and I don’t think stocks are cheap, but in general, the optimists triumph in investing. I have been shaving down risk positions, but with the Fed doing nutty things like QE infinity (whatever it takes), buying corporate bonds and doing direct lending, I don’t see how the markets fall hard now. The dollar may be worth less when it is done, but I think it is likely that you will have more ten years from now by investing in stocks and risky assets like stocks, than to invest in safe assets.

When the Fed shifts, things will be different. As Chuck Prince, infamous former CEO of Citigroup once said:

“When the music stops, in terms of liquidity, things will be complicated,” Prince said. “But as long as the music is playing, you’ve got to get up and dance.”

What we have learned 10 years after Chuck Prince told Wall St to keep dancing

As I wrote in my Easy In, Hard Out pieces, the Fed will have a hard time removing stimulus. They tried and the market slapped them. Now they live in a “Brave New World” where they wonder what will ever force them to change from a position from a position of ever increasing liquidity. They try to not let it leak into the real economy, so there is little inflation for now.

But there is no free lunch. Something will come to discipline the Fed, whether it is inflation, a currency crisis — who knows? At that point, “things will be complicated.”

So what do I do? I own assets that will survive bad scenarios, I raise a little cash, but I am largely invested in stocks. To me, that is something that balances offense and defense, and doesn’t just focus on one scenario, whether it is a disaster, or the Goldilocks scenario of TINA.

The Troubles of Hedging Inflation in Retirement

Photo Credit: frankieleon || Even with low inflation, money shrinks. Wages move with inflation, few assets do.

There’s no free lunch. The ideal of an inflation-protected defined benefit plan was indeed wonderful, but the costs were prohibitive. Few companies were willing to shoulder the costs of them, and what few were willing ran into the roadblock of the IRS telling them they could not put too much into their defined benefit plans — for the IRS feared it was a tax dodge.

By nature the IRS is shortsighted, and could not appreciate the idea that you needed more assets than the liberal (meaning you don’t need to contribute much today) funding formulas said they would need. The IRS wants taxes now. They don’t care about taxes five years from now, much less thirty.

As it is today, most of us (including me), are stuck in the box where we have to make our assets last over our retirements. There are no guarantees. How do we make the assets stretch?

It’s a tough problem. I often talk to my friends about the challenge, because we really don’t know whether the idiotic policies of our government will lead to inflation or deflation as a result of the crisis. Most people assume the government will inflate, and that seems to be an easy solution.

But they didn’t do that to any great extent in the Great Depression or in the 2008-9 financial panic. I’ve got bad news for most people: the government of the US, nay, most governments tend to favor the rich. As such, they tend not to inflate aggressively.

But as with most matters in economics, past is not prologue. Who can tell what the government might do in an entitlements crisis mixed with a weak dollar? What happens when so much credit is extended that foreign creditors distrust the value of the dollar (or euro)?

But suppose inflation is your worry. How can you hedge?

First there is storage: t-bills and gold. You won’t earn anything, but you won’t lose anything either.

Wait, why not buy gold miners? I class gold miners in the basket of industries that I call “cult industries.” Cult industries attract businessmen and investors that are “true believers,” who have a view of the world that says the activity is more valuable or cool than most other industries.

The problem with gold miners is depletion. Has the price of gold risen? Yes, but so has the cost of mining gold. There are many people who have bitten the romantic lure to mine gold, and as such, typically gross margins are poor. Buying gold miners has been a bad bet for a long time. So just buy a little gold instead, and not the miners.

Short duration bonds can be useful if their yields are higher than expected inflation plus default losses. Otherwise, bonds are usually not a good hedge for inflation.

With stocks, for the market as a whole, rising inflation is a small net negative. Businesses will raise their prices, but a higher cost of capital overall will make stocks lose ground to inflation in real terms.

But if you tweak your stock portfolio, and pursue either a low P/E approach, or one that favors a overweight of cyclicals, you can use those stocks as a hedge against inflation. Just be aware that when the cycle shifts to deflation, those stocks will underperform.

Real estate typically does well in times of inflation, just make sure any loans you have against the real estate won’t reprice upward to reflect the new higher interest rates.

That’s my quick summary for asset classes. Before I close, I have a few words regarding the unique ways that inflation affects seniors:

First, inflation affects you more because you don’t have wage income coming in. Wages mostly adjust to inflation — if you have work, that is a source of support.

Second, things that are necessary — food, energy and healthcare, have tended to inflate at a rate faster than other goods and services. That might not be true of energy now, but it was true for a long time.

My main bit of advice is to be conservative in your spending. That’s the one thing you can control. Making assets last for a long time, is difficult, but it becomes impossible when your asset levels get too low.

With that, invest wisely. Personally, I would pursue a middle course that partially hedges inflation risk, because the cost of being wrong on either side is significant.

Don’t Lose Your Head

Photo credit: David Seibolid || Oh dear, you lost your head!

So we had a hard market day yesterday. Maybe COVID-19 will resurge in the USA. The great thing about the USA is that no one is ever truly in charge. Power is shared. Most of the time, that’s a good thing.

I am not saying that it is time to buy, unless it is small trades. I bought 0.7% of stocks yesterday as the market fell 5%+. My aggregate cash position is around 20% of assets. After buying as the market fell in March, I was selling off stocks in May.

Did I not believe the rally? Sure I did, but there are degrees of belief, and I kept selling bits as the market rose.

Now let me tell you about two former clients. One was retiring, and wanted to move his assets to a firm I had never heard of. He notified me the second day after the bull market peak in February. I did not argue; I just liquidated the account for him. As the market fell after that, he told me to delay selling — the market would come back. I told him he had already sold.

Now, the new manager was incompetent in rolling over the assets. I was astounded how long it took, even with me helping them. As such, the client got a bad idea, and took 2/3rds of the assets and bought an equity indexed annuity decently past the recent market bottom. The insurance company knew how to roll assets. I wish my client had asked me regarding this — EIAs are “roach motels” for cash. They don’t return well, and you can’t get out of them. Your money dies there.

The incompetent asset manager ended up managing 1/3rd of the cash they thought they would. My former client is ill-served both ways.

Then there was the second client. He seemed to be happy and was interested in good long-run returns. In my risk survey, he scored normally. But when the market fell hard in March, he panicked and wanted to liquidate. But he asked my opinion on the matter. I told him that quick moves of the market tend to reverse, and that the securities that he held were well-capitalized, and even if the market fell further, they would not fall as much.

Then he told me that he never wanted the portfolio to fall below a certain level which we were at that point close to breaching. This was new information to me, and I said to him, if that’s the case, you should not be investing in stocks. Either change your goal, or change your asset allocation.

For a day, he realized he should be willing to take more risk. Than the market fell hard again, and he told me to liquidate.

I did so.

And it was the bottom.

So what is the lesson here?

It’s simple. Choose an asset allocation that you can live with under all conditions, and stick with it. This is the same thing that I tell the risk-averse pastors that I serve on the denominational pension board. And if you are not sure that you can live with it, move the risk level down another notch.

A second lesson is be honest with yourself, and also with your advisor, about your risk preferences. Most advisors that I know are happy to adjust the riskiness of client portfolios. There is no heroism in taking too much risk.

As I have said a number of times before, I have run my portfolio at 70/30 risky/safe all of my life plus or minus 10%. I personally could run at a higher level of risk, but I would rather not take the mental toll of doing so.

And when the market moves, I trade against it — but not aggressively. I am always moving in the right direction, but slowly, because I am never 100% certain where mean-reversion will kick in.

Yesterday was tough. Big deal. Days like that will happen. It’s part of the game. As for my second client, he took more risk than he was comfortable with, and ended up leaving the game, which is the worst outcome under normal conditions.

Sun Tzu said the most important task of a general was to understand himself and his enemy. My second client did not understand his own desires, and he did not understand how volatile the market can be.

As such he lost out — as did the first client in other ways. And thus to all I say, “Choose an asset allocation you can live with under all conditions, and stick with it.” You will be happier, and you will do better if you do so.

Saving, Investing, and Storage

Photo Credit: Jason Woodhead || Forget the United States Oil Fund — if you want to own oil, buy a tank and store the oil on your own property. ?

This should be a short post. Buffett likes to own T-bills when he doesn’t have anything that he wants to buy. Why? He is storing value until the time comes when he can buy something that he thinks offers a superb return over the long haul.

And now for something that seems completely different: commodity investing, when it was introduced in the nineties, offered “yield” from rolling the futures contracts from month-to-month. That ended when the trade got too crowded, and the “yield” went negative. The ETFs that pursued these strategies were inventory financing charities in disguise. They still are, even though their strategies are more complex than they were.

Think for a moment. Why should you earn a yield-type return off of owning a commodity? Really, that should not exist unless there is a scarcity of speculators willing to let producers hedge their risk with them. There is a speculative return, positive or negative, from holding a commodity, but in the present environment, where there is no lack of people willing to hold commodities, there is no yield-like return, unless it is negative.

As a result, commodities should be viewed as storage, not an investment. Do you think in the long run that gold will be more valuable than it is today? It might be wise to store some away. That said, you have to be careful here. In inflation-adjusted terms, most commodities have gotten cheaper over time, with occasional violent rallies that convince people to speculate (all too late).

Storage is not investing. Storage tucks something away, and it will not change, even if its price changes because of changes in the economy.

Investing is far less certain — you can lend to or buy equity in a venture which could produce astounding returns, or you could lose it all, or something in-between. With investing, it is rare that you will end up with what you started with.

This is not to say that storage is a bad thing — we exchange our savings in bank balances to store value in a different form. A bank could go bust. If enough go bust at the same time, value could be lost if the government does not back up the FDIC. Holding T-bills preserves value to the degree that the government is willing to pay on its own debts in fiat currency, which is pretty likely.

Holding a commodity with a price you think will correlate strongly with the prices you will experience in retirement is not a bad idea. That said, it is storage. It will not grow your purchasing power the way that investment will.

As such, I encourage you to mostly invest, and store a little. Storage is more certain, but has no return. Investing has returns, both positive and negative, but generally over time provides more value than storage.

PS — owning a home, except in a crowded area that is growing, is not an investment but is storage. You should not expect capital gains in real terms from owning a house. That said, it will provide you with rent-free living for a long time once the mortgage is paid off. (Please ignore the property taxes, insurance and maintenance costs.)

What I Wasn’t Looking For

Image Credit: Sean MacEntee || Should I have gotten a picture of a guy in a bathrobe?

Dear Friends,

I may occasionally write opinions that are controversial, but I try not be controversial as a rule. So, when I wrote my piece yesterday, I was not looking to make any huge statement regarding Berkshire Hathaway. Yes, I might be a little disappointed in Buffett’s lack of action, but I still think very highly of him. Of all investors alive today, he is the one who most deserves to be studied. Ben Graham had no better pupil. Same for Phil Fisher. And as far as Henry Singleton goes, Buffett has outdone him.

As such, I was more disappointed than excited when I saw the article at Marketwatch entitled Warren Buffett’s ‘outdated view’: One longtime fan is considering dumping his entire Berkshire stake.

I don’t mind media coverage of my blog. Really, I like it. And yes, I am a longtime fan of Buffett who might sell the remainder of my stake in BRK, but why should anyone care about that? I don’t manage that much money.

This is what I tweeted:

Yes, I sold half of my stake in BRK recently, but that only removed what I had added during the crisis. The amount I hold today is roughly the same as what I held on January 1st, 2020. I am sorry that I didn’t say that yesterday.

I had a thesis that Buffett would take advantage of the crisis, and buy some amount of stock. That was a major reason why I doubled my position; the secondary reason is that BRK is a safe asset.

That Buffett did nothing surprised me, and I sold half for a moderate gain. If Buffett has such a long time horizon, he missed some opportunities.

I want people to read what I write, but I hate sensationalism. Why else do I have relatively boring headlines for my posts? I know how to write exciting headlines and I don’t do it. I am here to educate in a friendly way. I am not here to be thrilling.

Anyway, enough. I wish Buffett the best, and hope his plans work out. The challenge for him in the present environment stems from the same reason that the Fed replaced J. P. Morgan. Now the Fed is replacing Warren Buffett.

And, for the cases where Buffett is buying healthy firms at a reasonable price, private equity takes his offer as a cue to outbid him… because Buffett never pays top dollar. Unless a private owner doesn’t want top dollar, Buffett will never win. He doesn’t participate in auctions.

Don’t get me wrong, I admire the discipline. But when your ability to source cheap assets goes to nearly zero, isn’t it time to re-evaluate whether the world hasn’t changed around you? After all, Buffett has reinvented his strategy several times already. Time to reinvent yourself again, Warren.

Full disclosure: Long BRK/B for clients and me

The Challenge for Warren Buffett

Photo Credit: Javier || THis is a much younger version of Buffett. Has the present Buffett learned to adapt?

Barron’s ran an article called Why Berkshire Hathaway Stock Has Rarely Been This Cheap. It was written by Andrew Bary, a man that I respect. I wrote a comment at the article, and it reads as follows:

So long as the government & its commercial paper financing arm (The Fed) is willing to create grants and credit out of thin air to rescue businesses, Buffett will not get opportunities to buy stock at the discounts that he has liked to see in the past. The cash pile will grow, & BRK stock will likely muddle.

Buffett’s justification for the cash pile changed at his last annual meeting, saying BRK needed it for catastrophes from their insurance underwriting. He has always faced that risk, and in the past has said that he might need $20B for that. (And he commented that his insurance companies were well-reserved, which is probably true.)

Choices for Buffett: 1) lower his hurdle rates for purchase down to levels where the government starts to act. 2) let the cash pile grow, and buy a huge business with significant moats that he could never dreamed of owning. 3) Start a slow buyback of stock and set a slightly higher multiple of book for where to cut it off. 4) Pay a special dividend, or, start a regular dividend. 5)Tell the managers of the operating businesses to look for decent-sized private businesses that they admire, particularly ones with succession issues. Send Buffett a proposal, and he will send a price. You can make the offer to the firm to join the BRK family. 6) Give Ted and Todd and the operating managers lower hurdle rates for investment. 7) Just muddle along, as it is now.

Order of likelihood: 7, 2, 3, 5, 6,1, 4. I don’t think Buffett will change much.

Why Berkshire Hathaway Stock Has Rarely Been This Cheap

My main contention with Buffett, as I am a shareholder, is that you can’t rely on the past when considering how far the market may fall when there is a crisis.

The nature of the US economy is that the Fed, and maybe the Treasury, or Congress, may borrow money to bail out those in distress, partly because the US economy is so indebted, that they can’t let debts be liquidated, lest we have a depression. Thus, low interest rates, low marginal productivity of capital, and low GDP growth.

In such a situation, the market will not fall enough to offer the values of a lifetime. The Fed will dilute the capital stock to provide a rescue, while Buffett finds himself diluted. Buffett’s money can’t buy a good company at a cheap price.

I sold half of my holdings in BRK recently, after I learned that Buffett did nothing during the recent fall in the stock market. Market values are relative, and there were certainly decent values to be realized in late March. You wouldn’t blow the whole wad, but surely you should have bought something.

I may sell off the rest of my holdings in BRK. Under the right conditions, I would buy more. The question is whether Buffett has an outdated view of how much the market could fall, given the skittish attitudes of economic policymakers.

Full Disclosure: long BRK/B for myself and clients

The Rules, Part LXVI

Photo Credit: Heather R || Round and round it goes, where it stops, nobody knows

Don’t bet the firm.

Attributed to the best boss I ever had, Mike Cioffi. I learned so much from him.

I was surprised to see how many times I mentioned at this blog how I considered and dropped the idea of writing floating rate Guaranteed Investment Contracts [GICs]. A lot of effort went into that decision, and unlike most decisions like that, the failures of competitors with a different view happened quite rapidly.

Also, this blog highlighted those that wrote terminable floating rate GICs later, and insurers that wrote contracts that had clauses allowing for termination upon ratings downgrades.

But that’s my own story. What of others?

The best recent example that I can give is oil producers both in 2015-6 and today. When oil prices plunged, many smaller marginal oil producers went broke. Why didn’t they take a more cautious view of their industry, and run with stronger balance sheets that could endure low crude oil prices for two years?

If you are managing for the price of your stock, maximizing the return on equity is a basic goal for many. That means shrinking your equity capital base, and living with the risk that your company could go broke with many others if the price of crude oil drops significantly. Of course, you could try to hedge your production, but at the risk of capping your returns.


The main idea here is to have a strategy where you stay in the game. This means running with a thicker balance sheet, and hedging material risks. What stands in the way of doing that?

Having a thicker balance sheet might give a firm a lower valuation, and attract activists that will attempt to buy up the firm, partially using the excess capital that aided safety. The antidote to this is to actively sell shareholders on the idea that the firm is doing this to preserve the firm from the risk of failure, much as Berkshire Hathaway keeps excess assets around for reasons of avoiding risk and allowing for the possibility of gaining significant returns in a crisis.


If you work for a single firm, most would say, “Of course! Don’t bet the firm! What, are you nuts!?”

But incentives matter. Where there are bonuses based on sales growth, sales will happen, regardless of the quality of them. Where there are bonuses based off of asset returns over a short period, you will have managers swinging for the fences. Where there are annual profit goals, there may be aggressive accounting and aggressive sales practices. But who cares about next year, much less the distant future? Who cares for the long-term interests of all who are affected by the firm?

Corporate culture matters. Excellent corporate cultures balance the short- and long-runs. They strive for excellent results while protecting against the worst scenarios. If the firm is able to survive, it can potentially do great things. Not so for the firm that dies.

To that end, incentives should be balanced. Those that play offense, like salesmen, should have a realized profitability component to their bonus. Investment departments should be judged on safety as well as returns. Conversely, defensive areas need to have some of their bonuses based on profits, and profit growth. It’s good to get all of a firm onto the same page nd be moderate, prudent risk-takers.

In closing, the main point here is that there is no reward so large that it is worth risking the future of the firm. Take moderate and prudent risks, but don’t take any risk where you and all of your colleagues may end up searching for new work. It’s not worth it.

Beyond that, to those that structure bonus pay, be balanced in the incentives that you give. Let them benefit from their individual efforts, but also benefit from the long-run safety and profitability of the firm as a whole. That will result in the greatest benefit for all.

The Future is More Variable than the Present

Photo Credit: Michael Dales || Futuristic, and with a twist

Well, I am back. This post will test whether images will post or not. My guess right now is not, so maybe I have more work to do.

Once I know that images will post, I will repost the deleted articles. On to tonight’s piece:


There are many who get annoyed at the concept that the market is rallying while unemployment is soaring.  Though this is not true now, others get annoyed at the market falling when the economy is humming along quite nicely.

My friend Howard Simons said something like, “Stocks aren’t GDP futures.”? There are several reasons for this:

  • When corporate bond yields fall, stock valuations tend to rise. When corporate bond yields rise, stock valuations tend to fall. Corporate bond yields fall when there is economic weakness, and rise when there is economic strength.
  • Stocks react to changes in estimates of future profits (or free cash flow). That doesn’t have much to do with present economic distress or success.
  • When there is a disaster, not all stocks share in the trouble equally. Companies with strong business models. low operating leverage and strong balance sheets get hurt less. The other companies fall into distress. The financial stress on those companies can lead to sales of assets, letting go of employees, and perhaps default. Those getting unemployed often work for a different group of companies than the ones where their stock prices are rising. (Creative destruction benefits society in aggregate, but not everyone benefits. Those who benefit do not all benefit equally.)

The main thing is there is only one present, and there are many possible futures. Shifts in government policy, particularly during times of stress, can rapidly shift estimates of what the future may hold, which makes the market move.

As such, I encourage caution when markets are moving rapidly. We know the future poorly, but in general optimism triumphs so long as there is overall stability. As I said 13+ years ago:

“Moderate bullishness should be the posture of most investors because absent famine, plague, war on your home soil, and aggressive socialism, markets tend to appreciate over the intermediate term.”

Closing Comments for 3-1-07

Now all that said, don’t assume that recent bullishness is fully correct. Valuations are high. Part of that is that corporate bond yields are low. But if anything happens that shifts expectations of profit margins down for a long time, there is room for the market to fall. Treasury yields might fall in a scenario like that, but corporate yield spreads would rise more.

It’s a good time to pick through your portfolio and find what might not survive so well if the economy does not pull together as quickly as we might like. Avoid marginal names that could be subject to distress. For non-financials and non-utilities, one test is to look at the ratio of debt to market capitalization, and consider scaling back positions where the the ratio is over one.

Remember, you are your own best defender. Moderate risk taking generally wins, so trim back the aspects of your investing that don’t fit that.

PS — If you want a “blast from the past” you can read the piece When the Sirens Sing, How to Avoid Giving in… I quote some of my old lost columnist conversation posts from 2006, including one entitled “More Things Can Go Wrong Than Will Go Wrong.” Maybe that could have been today’s title.

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