Wealth International, Limited

Finance Digest for Week of January 16, 2006

Note:  This week’s Offshore News Digest may be found here.


This installment of the Forbes semiannual mutual fund survey grades the performance of roughly 2,500 U.S. and non-U.S. stock and bond funds through both up and down market cycles. Funds can be sorted by up market grade, down market grade, name, return,| yield, expenses, and charges. Best buys, which combine low costs and good risk-adjusted performance, in different fund categories are identified.

Link here.


The world is in love with the iPod, and Wall Street is in love with Apple. The iPod, which has 76% of the MP3 music player market in the U.S. and 50% in Japan, has turned Apple into the kind of darling it was when it went public a quarter of a century ago. In the past four years Apple’s shares have climbed 6-fold to $72, or 46 times trailing earnings. The hip brand image has infected the rest of the company’s product line. In fiscal year 2005 Apple sold 4.5 million computers, 38% more than it did the year before. Apple’s top line for the year ended September 2005 was $13.9 billion, better than double what it was four years earlier.

But this sales bounty masks a worrisome downward trend in profitability. Apple’s computer business, which contributes 45% of sales, has a gross margin of 30%, estimates Eugene Munster of Piper Jaffray. The iPod, with a 33% (and rising) share of sales, has a margin of only 20%. The other businesses linked to the iPod – such as the iTunes Music Store and and iPod videos – do little more than break even, analysts estimate. Apple’s iPod and music businesses are growing much faster than its computer business. It is highly likely under these circumstances that Apple’s overall gross profit margin will decline.

Once you turn down the hosannas on the music player, you are left with a company with no hammerlock on the technology (Creative holds the patent to the interface for MP3 players) and no unique operational advantages (such as Dell’s made-to-order computers). Founder-evangelist Chairman Steve Jobs has a cult following among certain computer users and the mostly worshipful attention of the business press. But it is unlikely that even his magic touch can alter the grim economics of consumer electronics gadgets: After a while they become commodities subject to vicious price competition. It happened to Sony’s color TV, to Motorola’s cell phone and to IBM’s PC. It takes a lot of guts to take on an icon like Steve Jobs, but Apple admirer Andrew Neff of Bear Stearns lowered his rating from a buy to a hold in mid-December.

Link here.


My last column about mutual funds (August 20, 2001) was an unemotional look at their pros and cons, concluding that individual stocks are a better investment for most Forbes readers. But look at the screaming banner the magazine put atop the page: “I Hate Funds”. No surprise that I drew much wrath from the fund industry. At some risk that an editor will attach another sensationalist headline to my ideas, I am going to venture into this territory again. A fund is a good tool for someone with only $50,000 in the market. But the average assets of this magazine’s subscribers are upwards of $1.6 million. You folks should buy stocks directly.

What is wrong with funds? Start with performance. Over the long term the average fund in pretty much every category has fallen short of the S&P 500 index or whatever other benchmark is relevant. Yes, there are some winners, duly publicized in fund surveys, but you do not know about these in advance. Published numbers, moreover, overstate average results experienced by investors, because loser funds disappear. Next problem is costs. Add them all up – sales loads, the published expense ratio and invisible transaction costs – and you could be spending 4% a year to have your assets in a fund. Costs can be minimized in an index fund, but then there is a third problem: taxes. The first 35 pages of Don F. Wilkinson’s Stop Wasting Your Wealth in Mutual Funds are worth the book’s $20 purchase price. Read them.

I suggested 53 stocks in 2005, including stocks re-recommended from 2004, and they collectively were up 14.3%, after a hypothetical 1% transaction haircut on new positions. Equal amounts invested in the S&P 500 (without haircut) at the same times were up only 3.4%.

Link here.


Last year was my 25th as a Forbes Columnist, but the market did not give me much of an anniversary gift. The struggle between bulls and bears in 2005 was reminiscent of 2004, with the S&P 500 even by October. Both times the market went on to rally later in the fall and finished the year ahead. At year-end 2005 the S&P clocked a 3% appreciation, in 2004 9%. With dividends added, last year’s S&P total return was 4.9%. The moderate gain for 2005 is close to the 5% I predicted last January. As a value investor I am gratified that, for the sixth consecutive year, value stocks outpowered growth, with the S&P Barra Value Index appreciating 3.5% last year compared with 2.5% for the S&P Barra Growth Index.

I made 23 recommendations here in 2005, which after a 1% fee for new purchases appreciated 5.1% versus 3.2% for identical investments put into the S&P at the same times. The Forbes scorekeepers do not include dividends, which in value stocks are customarily rich. Adding them back would have widened my spread over the market return.

What should we look for in the economy during 2006? My forecast of a year ago is worth repeating. Higher inflation, which could accelerate this year, and a continuing large federal budget deficit are likely to cause interest rates to rise through the year. However, I still expect a reasonably good year for stocks with the S&P 500 rising 10% or more including dividends. Stocks tend to get hurt by inflation in its early stages, but then they catch up after the first year or so of an ascending CPI. I think we are at this inflection point now. Only if there is a really sharp inflationary spike will the market is rise be delayed. Company earnings should continue to increase. Large-size issues, which have trailed mid- and small-cap stocks for five years, should outpace them this year. Large-caps are much cheaper at this stage of the cycle.

Link here.


At the start of a new year hopes run highest. Take Investors Intelligence, the weekly newsletter that publishes a seismogram of market sentiment. In its recent poll of 100-plus newsletter writers, bulls outranked bears 3-to-1. As a card-carrying contrarian I take the opposite point of view. I think investors are in for a rough ride in the year ahead. If you look around, you find inflationary pressures everywhere. After 13 Federal Reserve rate increases in 18 months, many assume the tightening is almost over. But I think that, in the face of rising inflation, rates have a lot more to rise. Whatever the Fed does, an antsy credit market will lead rates up. Higher rates are bad for stocks.

Right now the average return on a money market fund is 3.65% – not bad for no risk – and serious competition for stocks. Beyond basic economics, note that the market has already made a tremendous move. The Russell Midcap Value Index has posted a 20.3% annualized total return since the bull began its run in September 2002. The large-cap S&P 500 is not exactly limping along, either. Since fall 2002 it is up 16.1% annually, including dividends. As a value investor I am a strong believer in regression to the mean. So I place my bets on tried-and-true, high-quality companies that have sat out this rally, particularly those in the upper end of the midcap range. They are geared to deliver consistent, predictable earnings that will survive the inflation that lies ahead.

In the past year my picks were flat (after a 1% deduction for hypothetical trading costs) – that is, they advanced 0% overall. That was shy of the 3.1% return you would have earned investing in the S&P 500 on the same dates. But over the long run value investing has worked for me. For example, my flagship small- to midcap Ariel Fund has posted a 14.4% annualized 10-year return, which beats the S&P 500’s 9.1% increase over the same period. After 25 years of professional investing I know that sometimes you are wrong and sometimes you are just early.

Link here.


We hear news that those diligent “unbundlers of risk”, those incomparable lubricants of our “flexible economy”, the men and women toiling in the reinforced concrete and plexi-glass canyons of High Finance have enjoyed rather a sumptuous Yule! Indeed, as press reports on either side of the Pond have breathlessly revealed, Wall Street’s $21.5 billion in bonuses, added to the $13 billion “trousered” in London’s Square Mile, takes the rocket scientists, vulture capitalists, and assorted structured-product salesmen up to $35 billion in extra moolah in just these two main temples of Mammon. For allowing my jaw to fall unrestrainedly open at the mention of such sums, I was taken to task as an ante-diluvian moralist and an unmitigated smokestack worshipper by a friend of mine who just happens to work in the bond market.

In my defence, I pointed out that one could not quibble that speculation should not be seen an evil, per se; nor could one pretend that the old-style banker who shepherded a man’s savings toward productive investment – using specialist knowledge and economies of scale of which the individual could not dispose – was inherently a malign influence. I even put aside forebodings about that $350 trillion sword of Damocles which is the derivatives market to allow that such instruments are a baleful presence by dint of their extraordinary scale and not because of their intrinsic properties.

Indeed, I went so far as to admit that, in their primary function of exchanging economic risk between actors with complementary needs, e.g., between farmers and millers, they are an unqualified plus, as they are when they perform the role of genuine insurance contracts drawn up between informed and consenting adults. But when financiers and traders get paid well enough to make Croesus kvetch for taking wholly asymmetric risks with phantom capital – risks underwritten by government institutions like the Fed and the FDIC; risks constrained by limited-liability partnership, or corporate status – this is not exactly a fair card game.

When arbitrageurs and junk-bond jugglers receive kings’ ransoms for indulging in manic, fiat money-fuelled churning – a hyperactivity which reached $1 quadrillion at the DTCC alone in 2004!! – thus financing illiberal and corrupt governments at home and abroad, and so distorting prices that economic calculation is rendered well-nigh impossible for producers and consumers alike, this is a different ball game altogether. With today’s outrageously skewed reward system – and the twisted monetary backdrop which makes it all possible – why would anyone waste their considerable analytical brainpower to deliver such less controversial benefits to humanity? As it does to everything else, inflation greatly misdirects human resources, too, and it impoverishes us all thereby.

Why train to be a farmer or a pharmacologist, when you can join Merrill Lynch and become a millionaire in your mid-20s, using someone else’s “capital” and benefiting from being an insider in the great Ponzi scheme in which we live. Though one should never be a fetishist for such tangible endeavours as manufacturing, ultimately, one must also recognize that all material human needs are met by industry; by the application and transformation of capital goods, resources, labour, etc., into products. In contrast, no City-slicker exotic options trader (or Zurich gnome!) is going to put food on your table or a flame in your furnace, no matter how quickfire his mind and steely his nerves. Sadly, such pursuits hold out a much more tantalizing prospect of gain. It is far easier to play the tables in a fiat market than it is to make them in a free one. And that is why the bonuses on Wall St. and in the city are a matter for shame, even if they should not be cause for envy.

Link here.


In the hallowed Ivy League halls of academia (where this author spent too many happy years before having to work for a living), they preach that it is the government’s duty, and the central bank’s mandate, to spend and print money to keep the economy afloat. The Keynesian trick is certainly easier to pull off when there is some inflation and the Fed can drop interest rates. Interest rates that are below the rate of inflation clearly subsidize old and new borrowers alike, and give an extra boost to the economy. Subsidized borrowers borrow and always find ways to spend money. Even though this economic stimulus trick consisted of a little extra government spending, recycled savings, and credit creation, recycled savings gave the economy the biggest boost, with credit creation adding some inflation to the spending mix. Then, everything began to change.

Cleaning up the first bubble required dropping interest rates to virtually nothing and creating an even bigger bubble in housing. The real estate bubble was far more powerful for spending because of the asset-backed and mortgaged-backed debt markets, which allowed for the virtual unlimited creation of new mortgage credit and money. Moreover, it was seductive telling a potential homeowner to feel comfortable about spending a lot of money to buy a home because property values were always going up. By 2004, it was time to help another sitting President to get re-elected. The housing market was booming and home equity extraction added about $800 billion (a year) to spending, even though this spending left a massive trail of debt.

For decades, America had an economic model built around recycling savings into investment. In a few short years, those savings have simply vanished and our society has become comfortably cavalier about borrowing far more than they earn. The first bubble in stocks taught Americans how not to save. The second bubble in housing taught them how to live off their house and spend even more than they make. From a macro-economic perspective, our country no longer has savings to recycle as part of a stimulus package. Instead, we are left with a massive debt to foreigners and it is growing at the rate of $700 billion a year.

It is important to note that the incoming Fed Chairman, Ben Bernanke, is the top academic student of the previous depression and a true believer in the power of the press … the Federal Reserve’s printing press, that is. We are clearly in the middle of a very interesting time. Our post-World War II economic model is totally broken. If our economic model is built on spending, where will the new spending come from? Without constant monetary stimulus, the credit-based U.S. economy would die. Our current economic model is similar to the one used by banana republic countries that are running hyperinflation and end up in hock to the IMF. Perhaps the Fed will have to raise interest rates higher than the capital markets currently expect in order to keep foreign governments happy.

What about the housing bubble? Mr. Bernanke may be left with only one course of action: Given housing price inflation of 50 to 100% in some areas over the past few years, the Fed’s goal for the next several years will be how to get inflation up without crushing housing prices because of rising interest rates. Getting money into the hands of consumers who cannot tap their savings (because most Americans do not have any), or use their credit cards (because they are over-extended – welcome to the new bankruptcy law), or draw cash from the home equity loan ATM installed on the side of their house, will be a real challenge. To get money into the consumer’s hands, the Fed will have to print more money and encourage the creation of more debt. The new economic model should be “inflate, or face deflationary collapse”.

In reviewing my own personal financial returns last year, I realized the following: Even though cash performed much better than stocks – without the risk or excitement – it did not keep up with inflation. Also, the stock market was flat but actually down after inflation. (The CPI underestimates actual inflation by 1.5 to 2% by excluding housing prices and using “hedonic price adjustment”.) My family’s portfolio of I-Bonds (inflation adjusted savings bonds) did better than cash and kept close to inflation, while our investments in gold and silver gave a strong real return after inflation. For 2006 and beyond, I expect the inflationary war on savers will continue, and I just do not see how financial assets – stocks and bonds – will keep up.

Link here.


Growth is great. Every investor knows that, and so do most business leaders, policymakers, and academics. On the surface, rapidly growing developing economies like China and India win the global growth sweepstakes, hands down. The clunkers in the developed world – especially Europe and Japan – pale by comparison. Yet the search for growth can be tricky. It is much easier for a smaller economy to chalk up rapid growth than it is for a bigger one to surge ahead at a blistering pace. At the same time, the differentials in growth rates can mask the opportunities still evident in the slow-growing larger economy. There is more to the global delta than meets the eye. As rapidly as China and India grew last year, their contribution to world growth was dwarfed by that of the more slowly growing U.S. and European economies.

Today’s world is increasingly caught up in a China mania, with growth rates literally off the charts in most aspects of Chinese economic activity. But as impressive as these rates of increase are, it is important to remember that China is still a relatively small economy in the broad scheme of things. Sure, if small economies continue growing rapidly ad infinitum, then, of course, they will eventually become big economies – overtaking the current leaders in the world. Such extrapolation seems to be the allure of the so-called BRICs paradigm – the rather simplistic notion that the developing economies of Brazil, Russia, India, and China have the potential to exceed the collective output of the G-6 developed economies over the next 40 years.

A lot can happen between now and then that can complicate any extrapolation exercise. In the meantime, it is critically important not to lose sight of the opportunities of the here and now. While I share all the excitement over China and India, it would be a shame to overlook the rest of the world. At this point in time, multinational corporations and global investors cannot afford to miss capturing the growth deltas of slowly growing large economies.

Link here.


If executive pay is out of control across America – and who would argue that it is not? – then the compensation being paid to managers running companies in bankruptcy nowadays can only be described as insanity squared. Bankruptcy experts say outsize pay at troubled companies is a new and disturbing trend. “Chapter 11 was traditionally about sharing the pain,” said Elizabeth Warren, a professor at Harvard Law School who specializes in bankruptcy, “but now it is more a game of feast and famine – starving the shareholders and creditors while the management team grows fat on big salaries.” A trend of excessive pay for officials at bankrupt companies was a troubling result of the lack of pushback from other stakeholders, she said. “The lawyers and management team are running the show.”

Link here.


The world is on the brink of a big switch from gas to coal as the preferred fuel for power stations, according to projections from Alstom, Siemens and General Electric, the world’s three biggest power equipment makers. Independent forecasts from France’s Alstom and Germany’s Siemens show that about 40% of the orders for electricity turbines in the next decade will be for coal-powered units, with the share of gas-fired plants falling to between 25 and 30%. GE said it expected to see a “more balanced picture” in terms of equipment orders, with gas being far less dominant than recently.

The shift to coal has been evident in the past year. Of the 120GW of new power orders, 20-30% were for gas-powered plants while 30-40% were for coal-fuelled generators. The shift is being triggered by technological changes that reduce the amount of pollution created by coal-fired stations and by rising disenchantment with gas as a fuel. There are concerns over rising prices for the fuel and worries about security of supply, underlined by the recent row between Russia and the Ukraine over gas pricing. Many countries in Asia, which is expected to provide half of all new power station orders in the next 10 years, lack ready access to gas reserves.

Coal’s re-emergence as a primary fuel for power generation is a reversal of recent trends. The dash for gas in power equipment was most evident between 1997 and 2001, when gas was the preferred fuel for 60-70% of new power stations and coal for 20-30%. Alstom and Siemens expect power station orders in the next decade to average 120GW a year. Spending on new power stations is expected to be $50 billion annually for the next decade. GE, in particular, could be hit. Though it is a large maker of steam turbines and has a strong presence in nuclear and wind power, its energy division is particularly focused on gas turbines.

Link here.


Sometimes appearances can be deceiving when it comes to how much debt is weighing down on overleveraged Americans. One anecdotal sign of the burdens American are struggling with: the ubiquitous TV commercial for a debt-consolidation service in which a suburban, upper-middle class man initially brags about his country club membership, spacious house and luxury car. “How did I do this?” the character asks. “I’m in debt up to my eyeballs. Somebody help me!” The man represents millions suffering from cash-flow poverty who have trouble paying for basic living expenses without taking on more debt.

Consumer debt has been climbing faster than personal incomes and shows no signs of abating. Personal bankruptcies hit an all-time high in 2005, according to Lundquist Consulting, Inc., a bankruptcy analysis firm based in Middlesex, New York. Although spurred by a new anti-debtor law going into effect late last year, more than 2 million Americans sought debt relief from Chapter 7 and Chapter 13 bankruptcy. U.S. consumer debt has almost doubled to $2.16 trillion as of October from about $1.3 trillion in 1998, according to the Federal Reserve. An even more troublesome figure is that consumer debt has consistently exceeded disposable personal income over the past half-decade at a 4.5% annualized rate.

“The economic growth over the last 20 years didn’t help two-thirds of Americans,” says Ellen Schloemer, research director for the Center for Responsible Lending, a consumer group based in Durham, North Carolina. “Many were forced to take on debt to cover basic expenses.” Her organization’s sampling of low- and middle-income Americans (representing 15 million households) in a study entitled “The Plastic Safety Net” found that seven out of 10 of those queried used their credit cards as a “safety net – relying upon credit cards to pay for car repairs, basic living expenses, medical expenses or house repairs.” A higher reliance on debt to cover living expenses, she says, is “creating a permanent underclass of debtors.”

Link here.

California, New York officials warn against more state, local government debt.

The trouble with the municipal bond market, which is where all these states and localities go to borrow money, is that nobody cares about it enough. There are a lot of reasons for this. Bonds are complicated. There is a lot of mathematics involved. And the actual transactions can be opaque. Taxpayers get steamed up if they find out the state is paying $10,000 for lawnmowers, or if the governor decides to spend $40,000 on a new bathroom for the executive mansion. Nobody says a word if the state pays too much on a bond issue or if it exchanges very short-term budget relief for some very long-term headaches on a future borrowing. Yet these things can cost millions of dollars.

The big message for all you taxpayers out there is that over the last few decades the municipal market has undergone changes that make borrowing much more complicated and dangerous. “Dangerous” can be defined as what happens when everyone says, “How did we get into this mess in the first place?”

Link here.


As housing prices soared last year, an eye-popping 43% of first-time home buyers purchased their homes with no-money-down loans, according to a study by the National Association of Realtors. The trend is potentially ominous. The real estate market is cooling in some areas, and rates on adjustable-rate loans are creeping up. As a result, some no-money-down buyers could owe more than their homes are worth. The median first-time home buyer scraped together a down payment of only 2% on a $150,000 home in 2005, the NAR found.

Already, home prices in many areas are declining, and the “For Sale” signs are hanging in front yards longer. There is now at least a 50% risk that prices will decline within two years in 11 major metro areas, including San Diego, Boston, Long Island (New York), Los Angeles, and San Francisco, according to PMI Mortgage Insurance’s latest U.S. Market Risk Index. “In a number of areas, particularly on the coasts, they have a high risk of price declines in the next two years,” says Mark Milner, chief risk officer of PMI.

Red-hot home building, acquisitions, remodeling and refinancing in recent years helped drive the economy and raise fears of a real estate bubble. Dean Baker of the Center for Economic and Policy Research says that if housing prices fall at least 10%, it could be even more damaging than the collapse of the high-tech stock bubble in 2000. “If we do get a spike in mortgage rates, and a modest decline (in the housing market) turns into a rout, there’s almost no bottom to that,” Baker says. “That’s a crash scenario.”

Baker and other economists are concerned that many lenders have pushed a series of creative but potentially dangerous loans to help more Americans afford a home. The traditional 30-year loan with a fixed rate remains the most popular way of financing, according to the Mortgage Bankers Association. But about one-third of homeowners take out riskier loans, such as interest-only or flat-minimum-payment mortgages. NAR President Thomas Stevens says he is not worried that nearly half of first-time home buyers put no money down, but adds, “If the number was higher than that, I’d be concerned.”

According to the report, first-time buyers accounted for 40% of all home purchases in the survey period – roughly in line with previous periods. In contrast to first-time buyers, 18% of repeat buyers financed 100% of their homes, the report said. According to the Realtors, the survey found that homeowners who use real estate agents sell their houses for about 16% more than people who sell on their own. The group also said the for-sale-by-owner market has gotten smaller, declining from 20% of total sales in 1987 to 13% in 2005.

Link here. “Flip This House” TV show home sale falls through – link.


Hedge funds earned a record $16 billion in fees last year as the returns on investment dwindled to almost half of the average a decade ago. The loosely regulated $1.1 trillion industry increased management fees to 1.44% of assets from 1.27% five years ago, data compiled by Hedge Fund Research Inc. show. The number of funds has doubled since 2001 to 8,500. The fees do not include additional performance payments, which averaged 19.2% of hedge funds’ profits in 2005. “Now people are charging much fancier fees, and they don’t make the same demands on themselves,” said Michael Steinhardt, 65, who closed his hedge fund in 1995 after 28 years in the business. “I was always anxious that my fees were egregious and that I had to have the best performance in the world to justify them,” said Steinhardt, who charged his clients a 1% fee, plus 20% of the profits.

The average hedge fund gained 9.2% last year after fees, slightly ahead of 2004’s 9% and well below the average annual return of 16% compiled during the 1990s, Hedge Fund Research reported. Lower returns are not deterring investors. About $338 billion poured into hedge funds during the past five years, according to the research group. Hedge funds historically have charged 1% of assets and managers have taken 20% of any profits they generate. Today, even new funds routinely charge a management fee of at least 2%, plus a 20% so-called incentive or performance fee, the minimum payment for any gain a fund makes.

Link here.


Wall Street and Main Street rarely agree about the price of anything. Sometimes Wall Street values certain assets above what private investors would pay. At other times, Wall Street prices out-of-favor assets well below what private investors would pay. The latter of these two pricing disparities is the sort of thing that causes us value investors to bound out of bed in the morning. Whenever we discover assets in the stock market that are selling for deep discounts to their real-world values, we have usually discovered a compelling investment opportunity.

Back in October of 2004, the stock market was assigning an insultingly low valuation to the shares of Orient-Express (OEH), an owner and operator of luxury hotels, restaurants and tourist trains. By buying OEH stock you were paying far less for comparable hotel assets than what private market buyers were paying for similar properties. Not only that, but hotel properties of all types had been commanding ever-higher prices in 2003 and 2004. The average price per room for luxury hotels in 2004 was about $140,000 and climbing. Super luxury hotels of the sort that Orient-Express owns were commanding a multiple of that price. The stock market was valuing Orient-Express at only $226,000 per room – not including the value of its interests in three fine restaurants and luxury trains. So I recommended the stock to my subscribers. Today, after more than doubling in price over the last 18 months, Orient-Express shares are no longer cheap. Orient-Express now trades at an Enterprise Value (market cap, plus debt, less cash) to EBITDA ratio of nearly 25 times. This value is nearly double what control investors have recently paid for hotel assets.

So what stock market assets are cheap today, based on private market values? One candidate would be timber. Peter Langerman, who runs the respected value-fund Mutual Series, likes timber assets. Private buyers, he notes, are paying between 16 and 20 times cash flow for timber properties. Yet, the stock market values most timber stocks at only around 8x cash flow. Langerman likes Potlatch, Weyerhauser and International Paper. In Capital & Crisis, we hold Plum Creek Timer (PCL), a timber REIT. It is another variation on the same idea and given the favorable tax status of the REIT structure, Plum Creek deserves an even higher multiple than timber assets held by more heavily taxed operating companies.

NewAlliance Bancshares (NAL) is a Connecticut-based thrift. Thrifts are not particularly popular right now. The price to tangible book ratio – a commonly cited ratio when dealing with financial institutions – is only about 1.8 times today. If you compile a list of recent transactions for thrifts and banks, you will see the acquisition multiple paid is closer to 3x tangible book. Here is a table that shows the top deals in 2005, limited to only those banks in the New England and Mid-Atlantic regions. The table is limited to deals of at least $100 million. Smaller transactions get smaller multiples. But even if you include all of them, the average price to tangible book ratio paid is about 2.5 times. NewAlliance is a substantial bank, the 5th-largest in Connecticut, which is a desirable and affluent market. The bank is over-capitalized, which is one reason it has been buying back its stock and boosting its dividend. Nonetheless, it remains a prime takeover target.

All the stocks I have mentioned provide an opportunity to profit from the pricing disparities between public market values and private-transaction values. So whenever you are trying to buy stocks cheap, you cannot afford to ignore what is happening in the private markets. Net-net, whenever Wall Street and Main Street disagree, opportunities emerge.

Link here (scroll down to piece by Chris Mayer).


The biggest puzzle of the past two years lies in the behavior of intermediate and long-term U.S. interest rates. They have stayed at their unusual lows in the face of general economic euphoria and a 300-basis-point uplift by the Federal Reserve. As a consequence, the yield curve has flattened much earlier than expected. While the consensus does not seem to worry, it is a fact that in the past this has always signaled an impending recession. Why not this time? Without offering any explanation, Fed Chairman Alan Greenspan recently argued that a flat yield curve would not act as a recessionary signal this time, while incoming Chairman Ben Bernanke sought to provide an alternative benign explanation with his “global savings glut” speech in early 2005.

The search for sound and logical reasons continues. Many see a main reason in the large bond purchases of Asian central banks. Mr. Greenspan, in particular, has argued that the low longer-term interest rates reflect the Fed’s eminent policy posture over the past few years, leading to the low core rate of inflation and sharply diminished risk premiums. None of these explanations holds water. Without question, the U.S. bond purchases by Asian central banks help to keep U.S. longer-term bond yields down. Yet they are grossly insufficient to accommodate the credit deluge flooding the U.S. economy and its asset markets at these low rates. To have low interest rates, it definitely requires more than just a low inflation rate and confidence in the central bank. It requires a sufficient flow of money to accommodate the ongoing credit expansion, including the bond purchases. What has happened in the U.S. in the past four or five years is an unprecedented money and credit deluge, holding short-term and long-term interest rates at record lows.

The first decisive question to ask in the face of this extraordinary development is the source of all that money accommodating the credit deluge. Principally, there are two possibilities. The difference is of crucial importance. The one source is the limited supply of savings; the other one is possibly unlimited inflationary money and credit inflation. It happens that in the U.S.’s case, the identification of that source is particularly easy. With savings in collapse, credit accommodation must essentially have come in total from inflationary money and credit creation. Recognition of this has to be the starting point for any assessment of the future course of U.S. longer-term interest rates. A total collapse of the carry trade, a sure consequence of an inverting yield curve, would send long-term rates soaring.

While Mr. Greenspan has argued that the yield curve no longer plays the same crucial role for the economy as in the past, we think that under these conditions it matters more than ever, both for the economy and the financial system. All the more puzzling is the stubbornness of the low long-term interest rates, defying the yield curve’s actual flattening. In the end one has to assume that leveraged speculators stick to their bond holdings or even add to them, expecting that a weakening economy will force the Fed to sharp new rate cuts.

Although strongly sympathizing with the downbeat forecasts for the U.S. economy, we have trouble with the optimistic assumptions of still lower long-term interest rates. The starting point for our doubts is the preposterous pace of credit expansion shown in non-financial credit, despite 12 rate hikes, with no sign of the slightest letup. So far, there has been zero monetary tightening. Money and credit growth do not have determined economic effects. It is decisive to whom and for what purpose credit is extended. In this respect, the past 20 years have witnessed substantial changes in all industrialized countries.

In earlier years, credit generally financed spending in the economy. Businesses borrowed for capital investment, and consumers borrowed for purchasing durables and housing. All this borrowing impacted national product and incomes directly and positively. But starting in the 1980s, new credit in the U.S. increasingly went into two other outlets outside the national product. One was soaring imports, as reflected in the ballooning U.S. trade deficit, and the other was asset purchases in the domestic and global markets.

People borrow to spend. Observing a sharply accelerating credit expansion, it is, in general, easy to identify the target of this spending. There cannot be the slightest doubt for anybody that the credit deluge of the past few years in the U.S. has mainly flooded into housing – boosting its prices. Yet policymakers and many economists dare to flatly deny the direct connection. In his first speech as Fed governor (October 2002), Mr. Bernanke said, “Another possible indicator of bubbles cited by some authors is the rapid growth of credit, particularly bank credit. Some of the observed correlation may reflect simply the tendency of both credit and asset prices to rise during economic booms.” It certainly needs a lot of courage to discard such a blatantly obvious causal connection as merely coincidence.

Link here (scroll down to piece by Dr. Kurt Richebächer).


The “mainstream” today is not what it used to be, given the power of the Internet, blogs, and other alternative media. Yes, large news outlets may still choose which facts to report, but it is never been easier for us folks in the boonies to discover what a journalist or broadcaster chose not to report. That said, it is still all too rare to find voices that are consistently independent and enlightening. If anything, the greater number of voices only proves the old axiom that quantity is no substitute for quality.

This, I believe, explains why Bob Prechter’s financial commentary has remained relevant for nearly 30 years. He was publishing facts and analysis that people could not get elsewhere before “getting it elsewhere” was cool. From the beginning Bob understood which overlooked or underreported facts truly mattered. Bob would also be the first to say that his method – Elliott wave analysis – is why his forecasts so often prove to be “tomorrow’s news today.”

Link here.


For all but a handful of maverick investors, the stock market is a mysterious beast. Like some mythological half-man, half-giant-walking-stick-made-of-charts, the stock market, seemingly tamed by armies of well-educated economists, is still not quite understood. What makes it tick? Why does it go up? Why does it go down? Theories abide, but most of them come short of fully explaining its enigmatic nature. Take the “January Effect” theory, for example. It states that come December, many investors sell the “loser” stocks in their portfolio for tax purposes, only to reinvest their money in January and thus give the stock market an early-year boost. The theory is apparently applied world over – although, it is hard to understand why the “January Effect” would occur in countries where tax laws are different from those in the U.S., as a Bloomberg columnist shrewdly pointed out recently.

The “January effect” is said to be especially kind to small cap stocks that, under the theory, are supposed to jump higher in January than blue chips. But in a fashion typical of mysterious creatures, the stock market does not always behave according to conventional theories. Last January, for example, U.S. stocks did the opposite of what the “January Effect” proponents were expecting. The Dow finished January 2005 down, and – as if to rub it in – the Russell “small cap” 2000 closed down for the month, too. However, in British stocks last year, the “January Effect” did show up indeed. Although somewhat lopsidedly: The projected blue chip rally never really materialized in January 2005, but the FTSE mid-cap and small-cap indexes pushed up strongly that month.

Why did last year’s “January Effect” skip the U.S. – the home of the tax system that allegedly birthed it in the first place – and showed up over in the U.K. instead? Explanations ranged from “investors being nervous of the slower earnings growth, higher interest rates, rising inflation, and pricey oil,” to “aware of the January rebound phenomenon, investors have learned to play it in advance.” Could be. Or, maybe the theory just misfired last year. Or, maybe it was not that reliable to begin with. What about this year? Well, U.S. stocks opened strongly; British blue chips, mid-caps and small-caps had a banner start, too – as did the other major European bourses. So the “January Effect” shows up one year and does not the next?

Link here.


Web site lets you loan as little as $25 to overseas entrepreneurs; eBay said to be in on it next.

If you have got 25 bucks, a PC and a PayPal account, you have now got the wherewithal to be an international financier. Thanks to www.Kiva.org, a Web site that connects lenders and borrowers from around the world, anyone can scan business proposals, photos and background information on potential borrowers and decide if the gambit has got legs. The concept of letting individual, small-time, lenders pick and choose which projects to fund is new in microfinance – the field of providing very small loans to start-up businesses, usually in the developing world. In the past the industry has been dominated by a handful of large non-profits that operate on grant money or raise cash in capital markets and then distribute as they see fit.

Although Kiva has been operating for just over two months and has served just 50 borrowers so far, all in eastern Africa, co-founder Matthew Flannery said there has been a large amount of interest in the site. “I sit in front of a tidal wave of money,” said Flannery, saying that the number of lenders far exceeds the number of people they can find to borrow the cash. “Businesses are funded in the same day that they’re posted.” So much interest that eBay’s PayPal is said to be working on a similar type of site. Although a spokeswoman for PayPal said the company would not comment on what she said “would at this point be considered rumors,” three people in the microfinance industry confirmed that eBay (Research) is developing such a site. Yet some in the microfinance field are concerned that simply sending more money to less developed countries will take attention away from the need to build stronger local financial institutions, fostering a relationship of dependency.

Kiva, unlike some Wall Street funds investing in microfinance, is not designed as an investment vehicle. Lenders on Kiva can hope to get their loan repaid in full, but they do not get paid interest. The “return on investment” comes in the form of pictures and stories of a business idea moving from a concept to a (hopefully) money-making reality. Using PayPal as an intermediary, lenders create an account at Kiva and can then browse through photos and business pitches from those seeking a loan. Pitches from people like Charles Ekoju, who wanted $500 to buy eight bails of used clothing to sell out of his house. Or Joseph Adongu, who got $500 to add better goats to his herd. The lender, whose loan can be combined with others to meet the needs of a borrower, is credited through their PayPal account as the loan is paid back.

Flannery and his small staff at Kiva do not go out into the field in Africa and make the loans themselves. Instead they partner with local organizations which vet the applicants, make the loan and then visit the business and report on the progress. The reports appear about once a month on the Web site. The level of lender interest, both from a site like Kiva targeting individual lenders and Wall Street firms investing in larger microfinance funds, is raising some concern. While generally supportive of the concept, some in microfinance are worried that direct cash investments may divert attention from the need to strengthen local financial institutions like banks, fostering dependence on outside money.

Link here.


Foreign investors raised their holdings of U.S. assets by $89.1 billion in November. Net holdings of Treasury notes, corporate bonds, stocks and other financial assets increased at a slower pace than the record $104.2 billion gain in October. The increase was more than enough to cover the month’s $64.2 billion trade gap and exceeded the monthly average of about $55 billion in the past five years. The net purchases, led by record demand for Treasury notes, followed a dozen straight increases in the Federal Reserve’s benchmark interest rate and may bolster the dollar, economists said. Rising interest rates helped the dollar rally against the yen and euro in 2005 and the U.S. economy grew more than twice as fast as its main European rivals in the third quarter.

“There’s no evidence that foreigners are tiring of U.S. assets,” said Marc Chandler, head of global currency strategy at Brown Brothers Harriman Inc. in New York. “The U.S. trade deficit is more than being financed by foreign investment. This continues to underpin the dollar.” Investors monitor the Treasury data as a gauge of demand for dollars. Purchases of Treasury securities rose by a record net $54.6 billion. Demand for agency debt increased by a net $9 billion.

Link here.


Taisho Nishimuro, who had a distinguished career as president and chairman of Toshiba, likely had no inkling of the melodrama in store for him when he became chairman of the Tokyo Stock Exchange last year. For over the last four months he and the world’s second-biggest exchange have lurched from one crisis to another. Indeed, on January 18, he found himself explaining to Prime Minister Junichiro Koizumi why the TSE had halted trading for only the second time in its 50-year-plus history. The quick answer to why the bourse stopped trading 20 minutes before close was an overpowering wave of sell orders related to an Internet company that few outside of Japan have ever heard of – a boom-and-apparently-bust outfit called Livedoor. Just two days ago, prosecutors raided it looking for evidence of alleged financial improprieties involving the booking of one merger by a subsidiary and possible doctoring of earnings.

The dump-Livedoor frenzy, which dragged other Japanese Net stocks such as Softbank and Yahoo! Japan, drove the overall market into the muck. The Nikkei 225 stock average fell 464.7 points, to 15,341, or nearly 3%, in the shortened session. Nishimuro assured investors that the bourse will open for trading at 9 a.m. on January 19. If so, it is likely to be a hairy day for investors who watched in awe as the Nikkei climbed some 40% last year. The scent of fast money that hung over the TSE in the closing days of 2005 has been replaced by a palpable sense of fear that 2006 could see a very nasty correction.

Livedoor might just be the trigger to broader sustained declines. And the reason for that has less to do with that company, whose own market value has collapsed and which faces a protracted legal brawl with government prosecutors, and more to do with sky-high valuations across many sectors of shares that a number of analysts were fretting about in the closing months of 2005. Sparked by real signs of economic recovery (Japan’s current expansion started in 2002 and shows no signs of losing steam), global portfolio investments rifled into Japanese stocks through much of 2005. Foreigners snapped up nearly $80 billion worth, a tsunami of money from abroad not seen since 1999. Online trading has been booming too, and the current rage in Tokyo among the tech-savvy set is text-messaging trades via sleek, clamshell-shaped, Web-enabled cell phones. In short, the trading sentiment in Tokyo has been on the frothy side for some time.

With Japanese stock price-earning ratios hovering around 29 based on forecasted 2006 earningers, vs. 18 or so for S&P 500-stock index shares, some brokerages started warning their clients the party would not last much longer. The popular iShares Japan Index Fund, a $10 billion exchange-traded fund (ETF) was heavily shorted on the American Stock Exchange in November. Aggravating the fear factor is the TSE’s desperate struggle to restore its credibility. Heavy trading volumes basically crashed the exchange’s trading system back in early November. A month later, a series of trading errors by both the securities arm of Mizuho Holdings, a giant financial institution based in Tokyo, and the TSE caused colossal embarrassment.

Things are undoubtedly looking up for Japan: Most economists see growth of 2% or so in 2006. (Remember, just three years ago, the Nikkei was hover at 20-year lows around 7,600.) And a bit of a shakeout would not be such a bad thing, either. Yet the Nikkei is clearly entering a stomach-churning stretch. Nishimuro may well be wondering if he should have opted for gentlemanly retirement after Toshiba.

Links here and here. After panic, Tokyo market rebounds – link.

Who the heck cares about “Livedoor”?

I hope you did not believe the rubbish in today’s news about what “triggered” Wednesday’s decline in Japan’s Nikkei stock index. Not that there is any question that the Nikkei did decline – it is down some 6% so far this week, and the early close of Wednesday’s session was the first such event in the 57-year history of the Tokyo Stock Exchange. But as for “why”, I guess it is too much for the U.S. financial media to do a 10-minute Google search and figure out the timeline.

The facts are: On Monday in Japan (after the Nikkei closed), authorities raided the offices and home of a flamboyant Japanese businessman on suspicion of securities fraud. This raid was the lead story on all local news broadcasts that evening. On Tuesday morning, Japanese stocks opened lower yet recovered by midday. Multiple news accounts noted, “Tokyo stocks rise in morning despite Livedoor raid.” Still, a powerful sell-off came that afternoon. All of this was before the Nikkei’s big problems on Wednesday.

Now, perhaps you recall the discussion on this page in December about the Nikkei, as the index had reached a 5-year high and showed extreme readings in several sentiment indicators. In fact, even though it does not usually discuss Japan, The Short Term Update did so three times in December, because the pattern and technical indicators were so unmistakably bearish. This is why I say that any attempt to link the Nikkei’s decline to a “news event” is rubbish. No one around here had heard of a Japanese company named “Livedoor”. It was not relevant to our analysis of the Nikkei then, nor is it this week.

Link here.

Japanese yen: sun rising on a new trend?

Japan has been in a decade-long economic rut, during which yen values have kept within a well-defined sideways range. Yet the same stagnation that others use to explain or excuse undesirable aspects of society offers us reason for optimism. The Elliott wave implications of the yen’s sideways pattern are clear: Prices just competed a special “contracting triangle” that has been in the making for 10 years, and the scope of the resulting move should be equally large.

Monthly Futures Junctures’ forecast is explicit: “When you spot a contracting triangle at any degree of trend on a chart, it’s worth getting excited about, because this wave pattern portends a swift move in price. But for me, the most exciting find is one that has taken years to form, because a multi-year, strong, trending market often follows. That’s exactly what I believe will be the case in the coming years for the Japanese Yen.” Given the sheer size of the triangle that has just come to a close in the yen, the resulting move in prices should leave an indelible mark on Japan’s next decade.

Link here.

Nikkei crashes … yen does nothing?

The “spotlight” story in the financial press this week was the plunge in the Japanese NIKKEI stock index. The less talked about story of the week has been the reaction of the Japanese yen to the Nikkei’s crash. Ask most forex traders: “If the Dow Jones Industrial Average suddenly crashed, what would you expect would happen to the value of the U.S. dollar?” and you will hear, “Well, the dollar would crash, too.” And when the Nikkei crashes, what should happen to the value of the yen? Also down, you say?

Not so. “While the sharp fall in the Nikkei was intuitively negative for the yen, the impact on currencies was murky” (Reuters). “murky”, indeed. despite the Nikkei’s wild ride this week – down 6% on Tuesday and Wednesday, then up 2.3% today – the USDJPY remained little changed, “leaving traders scratching their heads as to how the Nikkei’s swing would affect the Japanese currency.”

Needless to say, the past couple of days have probably shaken the faith of many traders who up to this point believed that news moves the forex markets. That is why, “There’s now a division in the market between whether to sell the yen and buy the dollar on the Nikkei’s moves, or sell the dollar and buy the yen” (Reuters). This confusion among the traders is probably the reason why the USDJPY has been trading in a relatively tight range this week. But not for long. Trading ranges indicate a temporary lack of conviction by market players – but when that conviction returns, the resulting moves are usually very, very strong.

Link here.


I hate January. It is a month when fools make predictions about what might (but probably will not) happen in the coming year. Articles are written about absurd phenomena like the “January Effect” – which is about as useful to investors as a six-pack of O’Doul’s is to an alcoholic. And every macroeconomic analyst in the nation thinks this will be the year he “gets it right.” Truth be told, none of us has a clue what will happen 30 seconds from now, let alone 6-12 months out. You do not know if oil will go to $100 a barrel, if gold will hit $1,000 an ounce, or if the housing bubble will finally burst.

And you know what? When it comes to investing, you should not care – at least not very much. Peter Lynch said, “If you spend 13 minutes per year trying to predict the economy, you have wasted 10 minutes.” Warren Buffett declared, “I don’t make guesses [regarding the economy], and when I do, I don’t pay attention to myself. Charlie and I never talk about macroeconomics. It’s fashionable for banks to have economists making forecasts. So they say that GDP will grow by 4.3%, instead of 4.6%. So what?”

“So what?” is right! Look, I do not hate macroeconomics. But as someone whose office is in The Daily Reckoning war room, I am exposed to far more than 13 minutes of this stuff a year. That cannot be good for my health – let alone my portfolio. I know we are in a commodities bull market. I know we are on the verge of seeing an inverted yield curve for the first time since 2000. And I recognize that the U.S. is deep in a pile of its own debt. But you know what? I would rather spend 10 hours a day plucking every hair from my body than worrying about trends that may or may not pan out. After all, how long have I been hearing about a housing collapse? How long has the dollar had a bull’s-eye on its back? And how long have we heard about the United States’ impending collapse as a mighty empire?

It is easy to make predictions. And if you make enough of them, you will probably even be right every once in a while (at least eventually!). But I have made a conscious choice in my career to leave the prediction-making business to someone else and to focus on something much more concrete, measurable and rewarding: uncovering solid businesses that are selling for discounts to their future worths. There is a reason Lynch’s Fidelity Magellan Fund grew from $20 million in assets in 1977 to $14 billion in 1990. There is a reason Warren Buffett is worth $30.5 billion today. There is a reason Ben Graham, Forrest Berwind Tweedy, Ralph Wanger, T. Rowe Price and Joel Greenblatt all made millions and millions on Wall Street. They ignored the market’s fluctuations and the macroeconomic trends of the day in lieu of investing in good, well-run and cheap companies.

Crazy, I know. But if you are up for getting a little crazy today, I have a solid, well-run company to throw by you. It is one I believe Lynch, Buffett and Wanger would own with their own money today. And it is the kind of company that you can own and forget about for the next year or two and not lose any sleep over. VAALCO Energy (EGY) is a small-cap oil company that cranks out 18,500 barrels of oil a day. I recommended it to my Penny Stock Fortunes readers a month ago at $4.12 a share. You macro guys may be horrified to know that my recommendation had absolutely nothing to do with the price of oil “potentially” rising to $70, $80 or $100 a barrel. And it had nothing to do with the fact that the oil and gas sector is up 54% in the last 12 months.

I recommended VAALCO because its sales are up 74.5% in the last three quarters. Its net income is up 32% in the same time. It is sitting on $45.3 million in cash to only half a million in long-term debt. And at 10 times earnings, a return on invested capital of 180% and an earnings yield of 36.1% – the company is cheap. But aside from the growth and value aspects, what I like the most about VAALCO is that it has discovered a niche in the oil industry that 1.) virtually no one else in the world can touch and 2.) most investors are too afraid to act on.

Nearly 100% of VAALCO’s oil reserves stem from its Gabon operations. Talk about scaring the bejesus out of most investors! That is exactly why this is a $5 stock and not a $10 or $15 stock, like some much smaller oil companies that operate here in North America. But eventually, good ideas get discovered. And this one will too. You see, what most investors do not realize is that VAALCO is so happy with production in its main Gabon oil field that it just signed a 5-year contract extension with the government of Gabon to continue drilling and producing oil. While everyone else is drilling in the Middle East, Canada and off the Gulf Coast, this little undiscovered small-cap company has a virtual lock on about 5 or 6 million barrels of oil a year. And at $60 a barrel and relatively low costs of operation (since it is already established in Gabon), it is not hard to see why its profit margins are almost double the industry average.

Link here (scroll down to piece by James Boric).


A rallying financial market is like a new romance. Warm, fuzzy feelings triumph over all other considerations. The impulse to criticize, or even to analyze, recedes into the anesthetizing bliss of gentle kisses, candlelit dinners and afternoon delights … like strolling through the botanical garden, for instance. But of course, suppressing one’s critical faculties rarely produces a favorable result, especially when romancing a financial market. So please allow those of us who are not so easily swept off of our feet to express the negative thoughts that very few investors can bring themselves to consider.

The financial markets currently contain a number of ravishing and alluring rallies. And though we are captivated by these beauties, we can no longer suppress the urge to examine their blemishes. To preview the conclusions of our dispassionate analysis, many of the financial markets that have been going up might soon start going down. Specifically, U.S. stocks, emerging market stocks and gold.

Although no single influence could explain the simultaneous rallies in these markets, they all seem to be responding to the flash flood of institutional money that has been pouring into financial assets since first trading day of 2006. This cascade of institutional money often produces booming New Year’s rallies, and this particular New Year has been a classic case. But we are leery of these fleeting financial floodwaters, knowing that they can disperse almost as quickly as they first rushed in. In particular, we are leery of the rallies in U.S. stocks and gold. We expect both of these asset classes to correct very soon, and only one of them to make a meaningful new advance later this year.

“There’s nothing like a one-way up stock market to force opinion into the bullish camp,” remarks Jay Shartsis, a seasoned options trader and savvy market observer. Shartsis notes that the usually correct commercial futures traders (the “Commercials”) have acquired a net short position in the S&P 500 futures that is larger than any prior short position of the past five years, save for two instances. Those two prior extremes occurred just before the market peaks of December 2004 and February 2001. “It can then be said,” Shartsis observes, “that the Commercials’ current short position does not at all support the notion that a new rally phase has started. Taken alone, this indicator suggests that this rally will turn into a bull trap.”

But the U.S. stock market is hardly the only financial market to display troubling blemishes. The rallies in emerging market stocks, oil and gold are all displaying defects as disturbing as bad table manners. We are particularly disturbed by the parabolic price spike in gold, and also by this precious metal’s remarkably extreme new-found popularity. “The Daily Sentiment Index (MBH Commodity Advisors) reached 93% bulls on gold last week.” Shartsis notes, “That’s an extreme not far from the super extreme 96% bulls recorded at the December peak of gold prices. Further, the distance in which gold is trading above its 200-day moving average has reached levels even more extreme than it did at that December price peak. This sector could use a pullback,” he concludes.

Meanwhile, the Commercials have also established a very large short position in gold futures. Their current net short position totals more than 150,000 contracts, compared to only about 35,000 contracts one year ago. The hefty bet by the Commercials on the short side of the gold market does not guarantee a selloff of course – not as long as Iran continues advancing its nuclear program, anyway – but neither does it bode glad tidings for gold investors. Net-net, our passion for both U.S. stocks and gold has faded somewhat, at least for the moment. But just because we find a blemish or two, does not mean we have to end the romance. For example, we are still in love gold … but the two us just need a little time apart.

Link here (scroll down to piece by Eric Fry).


It is a central tenet of credit bubble analysis that if an expanding Financial Sphere provides easy credit availability and abundant marketplace liquidity (prospective purchasing power), the Economic Sphere will undoubtedly conceive of ways to spend it. It is also critical to appreciate that a rapidly expanding Financial Sphere creates its own reinforcing (cheap) liquidity. And it is the nature of evolving Bubbles to circumvent processes that would typically marshal adjustment and self-correction. For the past several years, Mortgage Finance Bubble excesses have fostered massive current account deficits that have been easily recycled back to booming U.S. debt securities markets. This has engendered only easier credit availability and general liquidity over-abundance. Credit bubble dynamics dictate that, if accommodated, credit inflation manifestations will strengthen and broaden. Excess feeds and is fed by credit excess until the unavoidable bust. These are fundamental analytical constructs to guide us as we look forward.

Contemporary Wall Street finance’s 1990s maiden foray into global credit bubble dynamics ended in spectacular disaster. Yet, here at home, the Fed and GSE’s post-Russia/LTCM reliquefication both emboldened the leveraged risk-takers and provided excess (“King Dollar”) liquidity for which to fuel the fateful technology bubble. The bursting of the tech/telecom debt boom gave rise to an historic collapse in short-term interest rates and Bernanke’s manifestos on “government printing presses”, “helicopter money”, “non-conventional” inflating measures and a “global savings glut”.

Importantly, Greenspan’s reflationary policies and Bernanke’s extraordinary rhetoric sanctioned Wall Street “structured finance” as a primary source of system liquidity, along with stoking the fledgling mortgage finance bubble, the mushrooming derivatives markets, and the empowered global leveraged speculator community to unprecedented excesses. The Fed was compelled to guarantee perpetually liquid financial markets; there would be absolutely no turning back and no middle ground in managing the boom. The unfolding global liquidity glut and the faltering dollar spurred a massive worldwide inflation in commodities, energy, real estate and securities markets. This unusual strain of inflation is currently in a rage, inflamed by the rampant inflation of dollar claims and the robust expansion of the vast majority of credit systems internationally.

As I see it, the U.S. system will soon face a significant test. The optimistic view has it that housing markets are slowing; that this will engender a moderating impact on consumption; and that this unfolding “mid-cycle” Goldilocks economic environment will prosper for at least the next several years. This, however, flies in the face of the credit bubble thesis that excess begets excess. Which will it be? Has the cuddly little bond bear already passed, or has the big bad bear market not yet even arrived?

Until proven otherwise, analytical discipline forces me to give this robust Inflationary Bias the benefit of the doubt. Indeed, it appears that signs of cooling in some key housing markets have mortgage yields, once again, in retreat. This should lend support to housing and consumption. The key issue today is whether recent historic mortgage Credit excesses can be sustained, even at somewhat reduced levels. At current rates and considering the backdrop, I do not see why not. But in addition, inflationary manifestations are in full bloom throughout the global economy. “Emerging” markets/economies are in the midst of an historic run. Additionally, we are in the initial stage of what has all the potential to progress into an unprecedented global energy and energy-conservation spending boom. Outside of energy, surging global commodities markets are driving stepped-up investment. Global M&A remains robust. It is also becoming increasingly clear that global technology/telecom industries are poised – markets willing – for another bout of spectacular spending excess. Excess begets excess, and we must these days ensure that our analysis expands beyond the U.S. consumer.

It is a most fascinating environment. For now, we should assume that current low market yields and liquidity over-abundance will sustain the mortgage finance bubble, while stoking other bubbling excesses. The Fed will feel the heat. This week provided a flurry of interesting anecdotes and data supporting the “Expanding Bubble Thesis”. When it comes to excess begetting excess, few manifestations are more conspicuous than those emanating from our federal government’s finances. Massive mortgage and Treasury Credit creation run unabated, in the process inflating asset prices and generating enormous corporate cash flows/profits (along with global liquidity). It is helpful to think in terms of the federal government simply inflating the quantity of Treasury bills in the global economy to pay for inflating expenditures.

This week saw a record $38 billion of corporate debt issuance. To this point, the bond market has shrugged off what will be ongoing record corporate and Treasury issuance. One would think that the marketplace would have some concern with supply or perhaps even fear of an overheated economy. There is little fear and lots of greed. And this market dynamic is, indeed, the greatest anecdote of excess begetting excess. You see, the greater the excesses – mortgage finance, commodities, global equity markets, credit derivatives, leveraged lending, leveraged speculation, and so on – the more the markets anticipate bursting Bubbles and a zealous Bernanke “reflation”.

Appreciating that Dr. Bernanke scorns “Bubble Poppers”, there is today every incentive to play myriad bubbles for all their worth. After all, wealth is there for the taking and fortunes for the making. Everyone should be rich. And, at this manic phase of systemic liquidity excess, the more fragile and vulnerable the system becomes to bursting bubbles, the more timid the policymaker and the greater the bias for bond yields to decline – begetting only greater excesses. Moreover, when circumstances now develop that pose potential systemic risk – the Iranian nuclear issue, for example, knee-jerk bond rallies work only to stoke speculative impulses and buttress bubbles. Years of incredibly rewarding credit and speculative excess, recurring bubbles, and repeated central bank marketplace interventions have irreparably distorted risk perceptions and marketplace dynamics.

And here we are – we can now clearly assay the serious flaw in Dr. Bernanke’s aversion to Bubble popping: It really boils down to policymakers coming to possess only two options, both unattractive. Option one is to act decisively and pop the bubbles. Option two is to accommodate the bubbles, watch them further intensify and multiply, and allow the manic crowd to get only more manic. There reaches a point where the middle ground has been lost. Act decisively and take the pain or cowardly watch excess beget precarious excess.

Link here (scroll down to last heading on page).


In 1998, at the dawn of the age of the DVD, Blockbuster made a decision that would change the future of Hollywood. Warren Lieberfarb, who then headed the home-video division of Warner Brothers, offered Blockbuster CEO John Antioco a deal that would have made the DVD the same kind of rental business as that of the VHS tape, which, at the time, provided the studios with $10 billion in revenue. Lieberfarb proposed that Warner Bros. (which, along with Sony, was launching the DVD) create a rental window for DVDs during which sell-through DVDs would not be available for new movies.

With this window, Blockbuster, which then accounted for nearly half of the studios’ rental income from new movies, would have had the opportunity to rent out DVD releases before they went on sale to the general public. In return, the studios would receive 40% of the rental revenues that Blockbuster earned from DVDs, which was exactly the same percentage they received for VHS rentals. In fact, it was Sumner Redstone, whose Viacom conglomerate then owned Blockbuster, who personally pioneered the revenue-sharing arrangement for video. Only a few years earlier, Redstone had told Lieberfarb, “The studios can’t live without a video rental business – we [Blockbuster] are your profit.” Yet, even though Lieberfarb was only asking that the same deal be extended to DVD, Blockbuster, perhaps not realizing the speed with which the digital revolution would spread, turned him down.

Nevertheless, Lieberfarb, determined to make the DVD a success, went to Plan B: pricing the DVD low enough so that it could be sold to the public in direct competition with video rentals. Wal-Mart, seizing the opportunity for an enormous traffic-builder for its stores, began selling DVDs like hot cakes. By 2003, the studios were taking in three times as much money from DVDs as they were from VHS videos. In this reversal of fortune, Wal-Mart replaced Blockbuster as the studios’ single largest source of revenue. Other mass retailers followed suit, often pricing newly released movies on DVD below their own wholesale price to draw in customers who might buy products with higher profit margins, such as plasma TVs. Blockbuster, with no other products to sell, became a casualty of this cutthroat competition for traffic. Not able to match these low prices, its rental business was decimated.

The other shoe dropped with the emergence of Netflix as a major online competitor for what remained of the rental market. (Blockbuster turned down the opportunity to buy Netflix for a mere $50 million, instead entering a disastrous home-delivery deal with Enron.) Netflix signed up over 3 million subscribers by 2005 by offering DVDs that could be kept as long as renters liked for a monthly fee. To compete, Blockbuster had to do away with its single biggest profit-earner: charging late fees to customers who kept videos past the due date. It also had to invest millions of dollars in a copycat online plan.

Meanwhile, even after many Blockbuster store closings, the company was paying the rent on over 4,000 brick-and-mortar locations in the U.S. Initially, opening new stores every week had provided Blockbuster with outlets for the excess inventory of used videos from old stores. The resulting proliferation of stores also provided a competitive advantage when most people rented videos and needed a nearby location to return them. But as people switched to buying DVDs or getting them by mail from Netflix, this plethora of stores proved a liability, leaving Blockbuster hemorrhaging red ink. Still losing money in 2005, Blockbuster had to renegotiate its loan covenants to avoid being forced into bankruptcy. By 2006, the company Redstone had bought in 1994 for $8.4 billion had a market value of under $700 million.

As far the studios are concerned, other than collecting the money that Blockbuster owes them for past movies, the video chain has little relevance to their future. Viacom perspicuously divorced itself from Blockbuster by spinning it off to its shareholders, and, as one Viacom executive told me, “Blockbuster will certainly not survive and it will not be missed.” It is another zombie in Hollywood.

Link here.


Kurt Wulff called his shot a year ago. It was the financial equivalent of standing at home plate and pointing to the right field fence, then hitting the next pitch out of the park. He did it in a Barron’s interview last year. Wulff, the founder of McDep Associates, followed Burlington Resources for years. It was one of his favorite stocks. Last year, he forecast the stock price would advance to $86 AND suggested ConocoPhillips might buy the company. Last month, ConocoPhillips announced a buyout of Burlington Resources for around $89.50 per share! Kurt, I am listening now!

In a recent Barron’s interview, Kurt reiterated his bullish stance on the energy sector. He believes we will have $150 per barrel oil by 2010. Kurt’s take on natural gas prices is similarly bullish. He thinks $15 per thousand cubic feet (mcf) is the right price. Regardless of the exact prices, I agree with his positive outlook for oil and gas. Kurt Wulff and I also happen to agree about the three companies that would be most likely to be taken off the board in acquisitions.

What does a giant oil company look for in an acquisition? Primarily, it wants proven reserves. Second, it wants potential reserves in the form of exploration properties and specific drilling prospects. Now that we have identified what the buyers want, how do you sort the wheat from the chaff? Just like in real estate, there are three important considerations: location, location, location. Which companies might be next in line to attract a takeover deal from a major oil company? To begin answering that question, we must look at the valuations of prospective takeover targets relative to recent deal prices.

When Chevron boosted its proven reserve base by 21% by acquiring Unocal for $16 billion, it paid $9.35 per barrel of oil equivalent (BOE). But Conoco’s bid for Burlington represented a price of almost $17.50 per BOE. Clearly, Conoco believes that Burlington’s sizeable exploration properties hold huge potential. Whatever the case, we can see that recent acquisitions took place between $9.50 and $17.50 per BOE. The table below, therefore, values prospective takeover targets at both price points. A look at prospective takeover targets indicates that most of the independent companies’ proven reserves are valued at more than $9.50 per barrel, but still less than $17.50 per BOE.

Now that the super-majors are shopping for reserves, which companies might be the next takeover targets? I would bet on Anadarko, Devon, or Occidental. All three companies have several things in common. First, they are selling at a significant discount to net present value. Second, their proved reserves are selling at less than 75% of current market prices. Finally, they have vast areas of prime, oil- and gas-rich, undeveloped acreage that an acquirer would get “for free” when buying those cheap, proved reserves. Next week, I will take a look at each of these companies in a little more detail.

Link here (scroll down to piece by Matt Badiali).


England is ahead of the U.S. Property prices rose first, faster and further. Now the boom seems to be over. “Houses on the edge,” is this week’s MoneyWeek cover story. Houses are about to fall off a cliff, the feature story tells us. Debt service costs have risen to their limit, nearly 22% of after-tax income, says James Ferguson. The last time that level was reached, in 1990, marked the beginning of a bust in the housing industry. Few people seem aware of it. Instead, there is an air of calm, complacency, and self-assurance in London. No bust has come. Instead, the market merely loses air, like a slow leak in a bicycle tire, or a broken music box winding down.

It is like the beginning of World War II, says Ferguson: “For the 8 months after the outbreak of WWII, from September 1939 to April 1940, during the so-called ‘phony war,’ so little happened that children [who had been] evacuated to the country were returned to London. Some probably argued at the time that it was all going to blow over without incident.” But then, the Panzers raced across Belgium, and bombs started raining down on London. “Just because the market has defied expectations for so long,” adds Scheherazade Daneshkhu in the Financial Times, “does not necessarily mean that the danger is now past.”

Over on the other side of the Atlantic, the market has defied no one’s expectations. People thought prices would go up; they went up. As near as we can tell, they are still going up in some areas … and going nowhere in others. The typical house in Santa Clarita, California, rose to $600,000 in December, up 15% from a year ago. “We are just not making anymore land,” said an especially clever real estate agent. But what is this? “Fed sees a housing slowdown,” reports the Associated Press. And in December, the rate of new-house starts went down more than expected. If the new rate holds, about 200,000 fewer new houses will blemish the landscape than the year before. Builders seem to be picking up their tools and going home.

Our guess is that the typical buyer is under pressure. Though he makes no more money, his energy bills are rising, his health care is more expensive (if he can still afford it at all), the credit card companies are putting up minimum payment levels, and, worst of all, he already has too much debt. More evidence that the lower- and middle-income levels are feeling pinched – from yesterday’s news: nationwide, the foreclosure rate is running 13% ahead of last year.

Americans, along with the British, seem to have reached a limit. It does not necessarily show up in the averages. If half the nation is getting richer and the other half getting poorer, the average will remain steady. Still, there is bound to be trouble sooner or later. More and more people are having a hard time keeping up. For the moment, America and Britain enjoy a phony prosperity – a financial peace paid for with debt. But the danger is not past. It grows daily.

Link here.


It sounded like much ado about something this past January 9, when the Dow Industrials closed above 11,000. The Wall Street Journal made it the page one lead the following morning, saying prices were “continuing one of the strongest New Year’s rallies in two decades.” One headline I recall said, “Dow Puts 11000 in Rear-View”, which of course suggests that objects in the rear view mirror would only get smaller as the trend kept on in the same direction.

Ooops. Not only did that object quickly re-appear in the front windshield, but today’s action actually pushed the car behind the line that it crossed in the first session of 2006 – in other words, today the Dow fell to levels it has not seen since mid-November. As for “why” the Dow Industrials lost more than 200 points in one session, the various articles I had read offered a combined list of 10 reasons – at which point I literally stopped counting (Osama bin Laden “acting up” was my favorite).

A few days ago, the inverted yield curve no longer mattered, and the splendor of “the January effect” was all Wall Street could talk about. As late as the close on Wednesday, commentators were going on about how “unaffected” U.S. stocks were by the huge sell-off in Japan’s Nikkei. Don’t hold your breath as you look through the weekend news for more gushing about those topics.

Link here.


Despite how well things have been going for China’s economy, there is one huge thorn that remains in the side of Asia’s new “powerhouse”: the stock market. The Chinese government has been very concerned about its poor health, and for good reason. After hitting an all-time high in mid-2001, the country’s main stock index, the Shanghai Stock Exchange Composite (SSE), has since lost more than half of its value. The glaring disparity between the Chinese economy which has kept up an average 8% GDP growth annually, vs. the SSE that is still trading near its lows, has been so disconcerting for the Chinese officials that they are finally saying enough is enough.

In June 2005, The New York Times reported that the Chinese government was “considering creating a $15 billion fund to help bail out the nation’s ailing stock market” and to avoid the danger of social unrest among the millions of Chinese investors who lost money in stocks. In June 2005, $15 billion represented about 10% of the total SSE value – quite a chunk of change. Result? Well, in the weeks following the bailout announcement, the SSE lost about 8%. And although towards the end of 2005 Chinese stocks did rebound some, they still remain near the lows the government was so desperately trying to pull them up from.

The Chinese regulators have not given up on the idea, though. In fact, now that they have to deal with the additional trouble of a pending real estate crash in Shanghai, officials are turning “increasingly aggressive in their efforts to restore investor faith in the market.” In the latest move, they are now seeking to “to aid mood of the market with a trial” of a company that was once the biggest Chinese stockholder. You could argue that it may be the old Communist “central planning” mentality that makes the Chinese so confident they can push the stock market around. Except, there is probably not a central bank out there that has not tried the same trick. But, as the NYT wisely observes, “government bailouts have a weak track record.” Do the Chinese really stand a chance of improving it?

Students of Elliott wave analysis already know the answer. From studying the financial markets for almost 30 years, we know that in any country with a free market system, what drives both the stock market and the economy is the social (or mass) mood of that society. Any attempt to control the stock market or the economy is ultimately an attempt to control the country’s social mood. No government is powerful enough to manipulate its people’s aggregate emotional state. Social mood changes for its own, endogenous reasons, and it does so according to an Elliott wave pattern. The stock market signals those changes – and, what is very important, it signals them before the economy does. In the 1990’s, Chinese stocks were first to show that the country’s mood was fast improving. The Chinese economy followed. Then in 2001-2005, stocks lost half their value, foretelling a negative shift in China’s social mood … will the economy follow again?

China is not a market we forecast (yet), but European markets we do. Would a possible economic crisis in China have any impact on them? Do not bet on it: Each country’s social mood (and stock market) follows its own path.

Link here.


I, Alan Aurifericus Nefarious Greenspan, Chairman of the Federal Reserve Bank, holder of the Medal of Freedom, Knight of the British Empire, member of the French Legion of Honor, known to my peers as the “greatest central banker who ever lived,” (I will not trouble you with all my titles. I will not mention, for example, that I was the winner of the prestigious Enron Prize for distinguished public service, awarded on November 1, 2001, just days after Enron began to collapse in a heap of corruption charges) am about to give you the strange history of my later years.

For I will dispense with childhood … even with young adulthood, and those dreary sessions with that terminally dreary woman, Ayn Rand, who could not write a compelling sentence if her life depended on it. I will also dispense with my own dreary years at the Council of Economic Advisors, and pass directly to the time I spent as the most powerful man in the world. For here are my real titles: Emperor of the world’s most powerful money, despot of the world’s largest and most dynamic economy, and architect of the most audacious financial system this sorry globe has ever seen.

Yes, I, Alan Greenspan, ruled the financial world. But who ruled Alan Greenspan? Ah … I will come to that, and tell you how, while presiding over the biggest boom ever I became caught in what I may call the “golden predicament” from which I have never since become disentangled.

Let me begin at the beginning. Scarcely had I settled into to the big chair at the Fed when a crisis was thrust upon me. And it is true, I responded in the conventional manner. There is no manual for central bankers, but there is a code of behavior. Faced with a financial crisis of any sort, a central banker’s first duty is to run to the monetary valves and open them. This I did in 1987. I was new to the job and probably did not open them enough. The U.S. economy lagged its rivals in Europe for several years. My old boss, George Bush, the elder, lost his bid for re-election in 1992 and blamed it on me. I resolved never to make that mistake again. Faced with a slew of challenges, shocks, uncertainties, crises and elections … ever thereafter, I made sure that every valve, throttle, level, switch and sluice gate was wide open.

But it was on December 5, 1996, that I had my first epiphany. That was the year that I made my celebrated remark about stock prices. I wondered aloud if they did not reflect a kind of “irrational exuberance”. In truth, whether they did or did not, I do not know. But what I came to realize was this: (1) People, especially my employers, actually wanted prices that were irrationally exuberant. And (2) they could become far more irrationally exuberant if we put our minds to it.

A successful central banker, in the age of compliant paper money, is one who is able to control the rate of ruin so that the rubes do not catch on. A little bit of inflation, they believe, is actually healthy. Have the economists not told them so? Issuing a little bit more money each year makes people feel richer … so they spend more; they hire more people; they build more houses. Everybody is happy. Everyone feels richer. What an elegant fraud! It is almost a perfect crime, because no one objects as long as it is done right. (My replacement at the Fed, Ben Bernanke, specializes in controlling the rate at which central bankers can steal from dollar holders without getting caught. He says that if necessary, he will “drop money from helicopters” should the currency fail to lose value fast enough. I predict that there will be a lot of people who will want to drop him from a helicopter … for reasons I will explain here.)

I return to my narrative. After I made my remark about “irrational exuberance”, I was called into Congress. The politicians who confronted me were the usual oafs and know-nothings. They made it clear that if I wanted to hold onto my job, I would have to stop worrying whether asset prices were too high; instead, I would need to do all I could to goose them up! It was on that very day, I recall it well, that what I had previously seen only in foggy theory came out into the clear, bright daylight of applied central banking.

No one wants honest money. No one. The politicians, bankers, investors, voters, and householders – anyone with a voice in the matter wants “easy” money. It is just too delicious to resist. … And yet, of course, I always knew the answer. Easy money only works by defrauding people into thinking they have more money than they really do. Easy come; easy go. They get it; they spend it. Before you know it, you have a boom. But people soon adjust their expectations. Prices rise to catch up to new money. Debt levels increase, and with them come heavier debt service costs. The magic fades. What can a central banker do? He can do the right thing. He can “take the punch bowl away,” as my predecessors used to say. But this is where the trouble begins. Take away the punch bowl, and they begin punching you! I recall they burned Paul Volcker in effigy on the Capital steps when he did it. They would have burned him alive if they could have gotten their hands on him.

Why should I, Greenspan, suffer such a fate? No, it was not for me. This was the “golden predicament” I faced. Yes, I knew well that the nation would be better off if the punch bowl were removed, but I knew that I would be removed too, if I did it. … It is better that the lesson is taught now, rather than 10 years from now. It is better that the lean times come on the next man’s watch, not on mine! That’s what I owe to old Ayn; she taught me who rules Greenspan – Greenspan! Ayn taught me the number one rule: Look out for Numero Uno.

I remember it so clearly. I was sitting in a House committee hearing room. My tormentors kept asking questions. I kept giving the kind of answers for which I later became famous … answers that did not say anything. And I thought to myself: if these lardheads want easy money, I will give them easy money. I will give them the easiest money the planet has ever seen! I will give it to them good and hard! And so, I did.

Since I joined the Fed, outstanding home-mortgage debt has jumped from $1.8 trillion to $8.2 trillion. Total consumer debt went from $2.7 trillion to $11 trillion. Household debt has quadrupled. And government debt, too, exploded. The feds owed less than $2 trillion in the second Reagan administration, a figure that had been almost constant for the previous 40 years. But under my direction, the red ink has overflowed like the Nile in flood – to over $7 trillion. … When I came to power, the United States was still a creditor. Now, it is a debtor, with more than $11 trillion worth of U.S. assets in foreign hands, a more than 500% increase since 1987. Who can argue with such a record? Who can compete with it? Who would want to?

But that is the smooth, perverse pleasure a cynical old man takes in his achievements. I have practically ruined the nation, and I know it. If you distributed the cost of the federal government’s programs, promises, and pledges to the voters, along with the nation’s private debt, the typical household, and the nation itself, would be broke. And yet, almost everywhere I go, I am revered as a maestro…saluted as if I were a war hero. It is as if I had won World War II all by myself. The same numbskulls that wanted easy money 10 years ago, now praise me for causing what they call “The Great Moderation”, as if there were anything moderate about America’s borrowing binge.

Others say that my real legacy is that I finally “made central banking work.” Yes, I made it work … just like it is supposed to work, giving the people enough rope so they could hang themselves. That is what they have done. Now, they dangle from a long rope of mortgages, deficits and credit cards. And I am delighted. Soon, people will be able to see how central banking really works. And poor Ben Bernanke will get the blame for it. He and his stupid helicopters … he almost deserves it.

Link here.
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