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Five for the Weekend #64

This has been a busy week for me, as far as my non-blogging life goes (which has been the case for about a year now). And I spent all day today (Friday) in a workshop/seminar. So I have no idea what the "big news" is out there, if anything is. But I still have five items for your consideration if you want to do some reading over the next couple of days.

• John Makin's article in Commentary (HT: RealClearMarkets.com) called, The Keynes Bubble, is something I confess to having not read. So I don't know if I agree with all the particulars, but I certainly agree we're seeing a Keynes Bubble in the American media. Keynes was a great investor. Yet that means nothing, IMO, about whether he was the great economist or the greatest economist of the 20th century. And let's face it, Keynes is known for his work as an economist, with not enough attention paid to his undeniably impressive track record managing investment portfolios.

• Portfolio holding Fairfax Financial has reported third quarter results. From Reuters: "The first option is to always keep our financial conditions strong, so we won't do anything at the expense of our financial condition and that also means keeping capital available for a hard market, whenever it comes," Chief Executive Prem Watsa told analysts during a conference call. "But after that we can buy stock, buy stock back, we can make some acquisitions as and when they come -- we have no plans to make any but we could -- and, of course, we could continue to hold significant amount of cash if we decide to pay some dividends out, continue to build our cash in the holding company," Watsa added. I've sold enough of FFH over time so that all my original investment has been gotten out. Yet it is still a large portfolio position, accounting for more than 7% of assets at the end of September.

• John Dizard writes in the Financial Times of the real reasons for the decline in bank lending: The policy people, in the White House, Capitol Hill, or the regulatory agencies can’t have it both ways. Less risky institutions mean tighter lending standards, which means there will be less credit-fuelled growth and more unemployed constituents.

• Are you a homeowner who is thinking about refinancing? Bloomberg's John Wasik recommends doing it now: It’s not time to play chicken. Lock in the best deal now. Mortgage rates have climbed over the last two weeks, according to mortgage buyer Freddie Mac of McLean, Virginia. At a 1960s- like national average of 5 percent, the 30-year rate isn’t far from its historic low of 4.78 percent, reached in April. As the economy heats up, it’s far more likely that rates will climb.

• With all the talk about the flu, I'm reminded of the 12-hour flu cure by Jeffrey Tucker of the Mises Institute. I'm not a doctor and I can't vouch for this. I will say that I've taken cod liver oil daily for several years. And on those rare occasions when I feel like I might be coming down with something, I'll take three spoonfuls a day. If you decide to explore this, do your due diligence. My only advice is, if you decide to take cod liver oil, make sure you buy the varieties with plenty of vitamin D.

And with that -- have a great weekend.

Guest Post from Saj Karsan

The following post is a guest post by Saj Karsan, who regularly writes for Barel Karsan, a blog dedicated to finding and discussing current value investments.

As the market has risen throughout most of this year, many market observers have noted that P/E values are looking rather inflated from a historical standpoint. But of course, earnings are lower than usual this year due to reduced revenue that was caused by financial shocks. So as investors, should we be willing to pay a higher P/E for now, on the assumption that earnings will soon pick up?

When considering the market in the aggregate, this is a very difficult question to answer. Some companies will have cost structures that prove too rigid, and will therefore be unable to adapt to a lower revenue environment. Other companies, on the other hand, will have flexible cost structures or will see revenue continue to grow, despite the downturn. But to determine which of these forces will exert more pull on the market's earnings in the coming quarters is not only extremely difficult, but unnecessary: unless you're trying to value the entire index, you don't have to answer this question for the market in the aggregate. Instead, you can try to answer this question for individual securities, which are much easier to understand.

For example, consider Key Tronic (KTCC), a manufacturer of electronic devices. The company has a P/E of 23, which makes it appear overvalued. But earnings are down because year-over-year quarterly revenue is down 15%. However, the company has little in the way of debt, and has the vast majority of its operating leases coming due in the near-term, giving it further flexibility in reducing its costs. Operating expenses are down 17% this year, and the company sees sales starting to rebound in January of 2010. In fact, based on KTCC's past margins and returns on assets (which it should be able to return to by continuing to cut costs and with a modest recovery in revenues in the years to come), it appears to trade at a normalized P/E much, much lower than the 23 that stock screeners currently display. (KTCC is a stock we've previously discussed here.)

Determining whether the market is over- or under-valued is a difficult exercise indeed. But by focusing only on those companies for which it is easier to compute earnings (circle of competence), and ensuring that companies trade at discounts to those earnings (margin of safety), investors put themselves in positions to profit in the long-term whether the aggregate market offers potential or not.

Disclosure: Author has a long position in shares of KTCC

If you enjoyed this post, consider subscribing to the Barel Karsan feed.

Christopher Wood Op-Ed in The Wall Street Journal

Today's Wall Street Journal runs an interesting piece by Christopher Wood of CLSA Ltd. in Hong Kong. This is up on RealClearMarkets.com, so it should be available to non-WSJ.com subscribers.

Wood, you may recall, was recently interviewed in Barron's. And he pens a newsletter called Fear & Greed, which I'm told is only available to clients of CLSA. Now back to the linked op-ed:

Happy days are here again in world stock markets. Yesterday's profit-taking notwithstanding, the Dow Jones Industrial Average is flirting with 10000 and the S&P 500 is up 60% from its March low. Still, if risk-seeking behavior has returned to financial markets, much of it is funded by borrowing increasingly cheap U.S. dollars. There is also very little evidence, if any, that consumption and employment are really recovering in America.

With the U.S. government stepping in to keep markets from clearing, today's U.S. economy in many ways resembles the post-bubble Japanese economy of the 1990s. Ultra-loose monetary policy and low demand for credit, combined with high unemployment and consumer deleveraging, could lead to a prolonged slump.

A bit further down:

Meanwhile, there's an unhealthy reliance on government for growth in America's increasingly command-driven economy. This is clear from the severe slump in car sales post "cash for clunkers." U.S. auto sales declined by 35% month on month in September to an annualized 9.2 million. It's also clear from the enormous role now played by government in the residential mortgage market. Government-guaranteed mortgages accounted for 98% of total mortgage-backed security issuance in the third quarter.

And, finally, this interesting bit:

The next bubble in asset markets will not be in the West but in emerging Asia, led by China. The irony is that the more anaemic the Western recovery proves to be, the longer it will take for Western interest rates to normalize and the bigger the resulting asset bubble in Asia. Emerging Asia, not the U.S. consumer, will be the prime beneficiary of the Fed's easy money policy.

The next asset bubble in emerging Asia? That's something to keep an eye on. And perhaps benefit from. If I keep some powder dry.

Microsoft Has More to Go

In retrospect, buying Microsoft (MSFT) earlier this year for $18.39 was a no-brainer. The company has an undeniably strong cash position and even pays a decent dividend. The stock has been in the upper $20s last I checked due to results announced last Friday.

Most of MSFT's good news stems from aggressive cost-cutting. But there's more good news. Windows 7 has been getting great reviews. And since many PC users never bothered to get Vista, there's plenty of pent-up demand for a new PC operating system. Or there should be. No, check that. There is pent-up demand but with consumers and businesses holding down costs wherever possible, we could still see surprisingly lackluster sales. Hey, anything is possible these days, folks.

Another winner of sorts may turn out to be Bing, Microsoft's search engine. It too has been winning rave reviews -- including from the likes of Fred Hickey. I've tried Bing and think it's fine, but I'll freely admit that I haven't made it my default search engine yet (I still use Google).

For now, I'm not trimming my MSFT position. I think the stock has more to go.

And we'll see more upside -- especially if we can get a recovery in business spending. I don't know how far cost-cutting can take us here.

Five for the Weekend #63

Here we are at the end of another week, which means it is time for five items for your consideration. Let's go.

• Allan Meltzer writes a compelling op-ed in today's Wall Street Journal: "As long ago as the 1960s, then French President Charles de Gaulle complained that the U.S. had the "exorbitant privilege" of financing its budget deficit by issuing more dollars. Massive purchases of dollar debt by foreigners can of course delay the crisis, but today most countries have their own deficits to finance. It is unwise to expect them, mainly China, to continue financing up to half of ours for the next 10 or more years. Our current and projected deficits are too large relative to current and prospective world saving to rely on that outcome."

• I came across this Canadian radio interview with the director of the Institute for Research on Unlimited Love, founded with seed money by John Templeton and the Templeton Foundation. It aired on the death of Sir John in 2008. This blog can't get enough of John Templeton, and I hope you find the interview enlightening and well worth a few minutes of your time.

• Scott Payton examines gold in The Spectator: Whatever happens to the gold price during the months and years ahead, John Doody, editor of Gold Stock Analyst, a fortnightly investment newsletter published in Florida, has a method for making a profit: investing in undervalued gold companies. ‘If the gold price goes up, we’ve got two ways to win. But if the gold price does nothing, we can still win on the undervalued aspect of our investments,’ he says. By September, Doody’s top ten gold stock picks were up 96 per cent since the beginning of the year. ‘With gold companies, everybody makes the same stuff and they can sell as much of it as they can produce, at the market price. So when picking gold stocks, you have to work your way back to cash [production] costs. If a company has a cash cost of $800 an ounce, it might not be worth much. But if it has a cash cost of $400 an ounce, it may be worth a lot. The market is not efficient. It does not value every company properly.’

• Staying with The Spectator, Edie Lush looks at Islamic finance: "The requirements of Islamic finance — lower proportions of debt to equity, a condition that the lender share profits and losses with the borrower, and a focus on transactions based on tangible assets — mean that Islamic banks have not become entangled in the toxic debt instruments that sideswiped Western banking giants. And while most of the West’s banks were in crisis, Islamic finance continued to grow — by about 15 to 20 per cent in each of the last four years."

• The finalists have been announced for the Cundill International Prize, founded by now-retired Peter Cundill, the legendary value investor. The winner gets the world's largest non-fiction historical literature award: "The prize, now in its second year, will be awarded to an author who has published a book determined to have a profound literary, social and academic impact on the subject. The university will grant the equivalent of one full prize of $75,000 U.S. and two “Recognition of Excellence” awards of $10,000 U.S."

Have a great weekend. See you next week.

Notable Notes from the Value Investing Congress

Jonathan of the indispensable Cheap Stocks blog posts some notes from the Value Investing Congress. Among the impressive cast is David Einhorn:

Einhorn opened his presentation with his thoughts on the importance of learning from bad decisions. He cited his 2005 IRA Sohn conference presentation on the merits of homebuilder NBC Holdings, which ultimately fell 40% as the homebuilding sector collapsed. Although the rest of the sector fell much further, an average of 70%, Einhorn learned the following:

• It is not reasonable to be agnostic about the big picture, a macro view is vital
• Even given the above statement, you can still be a stock picker

Einhorn went onto give a stirring speech about what he believes to be the current macro risks:

• The government is too focused on the short-term, too focused on getting re-elected.
• Too much focus on special interests (protection of banks, for one)

Einhorn believes that the lesson of the Lehman collapse, a company that he very successfully shorted, is that companies should not be so big that their collapse can jeopardize the entire financial system.

He went onto state that he has changed his view about the validity of owning gold, given its propensity to perform well not just during inflationary times, but when monetary policies are poor in general. In terms of form of ownership, Einhorn owns physical gold, believing that to be even more efficient than the ETF.

As you know, I own a "double" portfolio position in the SPDR Gold ETF (GLD). But I agree owning the physical metal is best, if one goes to the trouble of storing it properly. Next best would be owning something like Central Fund of Canada (CEF), the closed-end fund, as long as it is trading at a discount. (It has been trading at a premium for a good long while now.)

I encourage you to read the entire Cheap Stocks posts linked. And I also think you should read the entire Einhorn speech (you can find it on Tuesday's RealClearMarkets.com). I'm not overly familiar with his long-term record, yet I find his talk compelling nonetheless. I like that he opens by freely talking about an investment mistake. My observation is that good investors are open about admitting mistakes.

Capital Southwest 2009 Investor Presentation

A reader and fellow shareholder in Capital Southwest (CSWC) recently commented that he'd like to hear more about the company. My response was (and is) that I would, too.

But CSWC management shuns the press and to my knowledge has never done conference calls. They put out quarterly reports and the very occasional press release. In this media/internet age some may find that disquieting. Not me and I hope not you.

Most important is that for every $1.00 this business development firm puts to work, management is on the hook for 20 cents. They're aligned with us shareholders.

If you're new to CSWC, you can access the 2009 Investor Presentation from last month here. Maybe these guys are becoming something of publicity hounds -- I don't remember them doing many of these back in the days when the late Bill Thomas ran the company. ;-)

The stock is down since I bought it. But never mind. I like this company and its management and I expect to being owning this stake for a long, long time. In fact, as reported here previously, this is the only company where my broker has been instructed to reinvest all my dividends.

And, thankfully, this bull rally has most of my stocks in the black. Yet CSWC ranks as a bargain. And, if I inherited a portfolio 100% in cash, the first thing I'd do is put 4% to 5% in CSWC.

The Invisible Costs of Avoiding Defaults

John Dizard's column in today's Financial Times touches on something long troubling many, including me.

Namely, that much of government policy here in the US is geared towards preventing overvalued real estate assets from falling to their true values.

And, as Dizard rightly points out, this is a criticism of the current and former presidential administrations.

Part of the piece:

Essentially, by never taking economically justified writedowns, the US economy will be jellied into low growth, like 1990s Japan but with junkier cars and without the fresh sushi.

As a liquidationist banker puts it: “Without recognising the losses and writing off the bad loans, you will not get price discovery. So prospective new capital will not find out what the property is worth, and, therefore, not be attracted to get the real estate market going again.”

It is not just faceless foreigners and insurance executives who will lose out. The US will not get new construction jobs, mobility for its workforce and companies, or tax revenues from new activity. But those are all invisible opportunity costs. The visible losses would be here and now.

Dizard's columns in the FT are always worth checking out. You'll want to read the whole thing if you subscribe to FT.com.

Will Emerging Markets Outpace Going Forward?

Famed UK fund manager Anthony Bolton thinks they very well might (HT: RealClearMarkets.com):

My contention is that a combination of consumers rebuilding their balance sheets, slower credit creation in this upturn than was historically the case, and governments being forced to cut spending or increase taxes will lead to lower growth than before the crisis.

The big question now is whether the relative growth advantage of emerging markets over the developed world has increased.

I think it has – particularly for emerging markets that are driven by domestic demand and investment. I am less keen on those markets where exports or commodities are the main drivers. One reason these are less attractive today is the fact that commodity shares and industrial companies were the leaders of the last bull market.

Further down:

If that is the case, then UK investors’ typical exposure to emerging markets, of about 15-20 per cent of an equity portfolio, could prove too low. Perhaps, for the next few years, they should consider having a majority of their exposure to markets that can provide higher growth.

But if all investors in developed markets make similar changes to their asset allocation, I believe we will have all the ingredients necessary for a new bubble to develop over the next few years in these volatile but rewarding markets.

Fasten your seat belts – we are in for a bumpy, but enjoyable, ride.

If you find Bolton's comments interesting, read the entire thing. This has been posted on RealClearMarkets, so I imagine it can be accessed without subscribing to FT.com.

Five for the Weekend #62

Well, the Bank of America results reported today show that the financial crisis is far from over. And with another weekend here, let's get right to five items for your consideration over the next couple of days.

• I'm a dedicated Mac user, though I've worked with numerous Macs and PCs over the years. But my personal preference for Apple products didn't prevent me from investing in Microsoft (MSFT) earlier this year. The new Windows 7 has been getting generally great reviews (I've yet to work on a system using it). Here's another on Bloomberg.

• John Dizard writes in the Financial Times about gold and goldbugs. "One of the advantages of being a goldbug now, or becoming one soon, is that it is one commodity whose price is not likely to be manipulated below its market-equilibrium level by the US government ("Them", if you prefer). There will be attempts to limit speculation in such essential commodities as oil, grains, or base metals, but a gold price rise would simply represent a successful devaluation. So while the goldbugs' conspiracy theories are chimerical, their investment strategy is at last aligning with that of the real world." I have exposure to gold through the SPDR Gold ETF (GLD).

• Famed UK fund manager Anthony Bolton proposes his 7-point banking plan in the Financial Times. "The past 12 months has been a near-death experience for the global financial system. If governments had not acted as quickly and aggressively as they did we might now be in a global depression. Although we can’t stop such financial crises recurring, we may be able to ensure that they occur less frequently and that they have a less universal impact than the crisis we have just lived through."

• Long-time Controlled Greed readers know I'm a big fan of Breakingviews.com and The Lex column (appearing in the FT). News broke this week that Thomson Reuters is buying Breakingviews. Here's a profile of Hugo Dixon, Breakingviews' founder (who used to edit Lex), in the Times of London.

• John F. Wasik argues in his latest Bloomberg column that -- unless someone will be living in the same neighborhood the rest of their life -- renting may make more sense than buying.

And with that, a great weekend to one and all.