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Joseph Calhoun
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Joseph Y. Calhoun III is the CEO of Alhambra Investment Partners, a registered investment advisory firm in Miami, FL. Joe, along with Jeffrey Snider, Douglas Terry, and Marcelo Perez, write Alhambra's global market commentary that covers the world’s stock, bond, commodity, and currency markets.... More
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Alhambra Investment Partners
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Alhambra Investments Blog
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  • Revenge of The Bankers

    Germany got a wake up call last week when an auction of 10 year government bonds failed to get bids for 35% of the bonds offered. While German bond auction failures are not as infrequent as one might imagine – six of the last eight auctions received fewer bids than the maximum amount of bonds offered – this one, coming in the midst of the European debt crisis, was perceived to be more ominous. If the strongest economy in Europe can’t sell all of its bonds, what chance does Italy or Greece have? Some have opined that this failure means the Euro crisis has entered a new phase and that Germany itself – the one government in Europe thought capable of ending the crisis – is now at risk. It was more likely a power play by Europe’s bankers intended to send a message to Merkel and Schaeuble. And it appears the message was received.

    Schaeuble has been at the forefront in Germany demanding that banks share losses in any sovereign bailouts that come via the European Stability Mechanism to be established next year (moved up from 2013). The failed German bund auction last week was the banks reply and Schaeuble almost immediately backed down. Friday, Schaeble told reporters that “(i)f we now manage to move toward a stability union, we’ll see how one might possibly adjust the treaty”. Bankers 1, Schaeuble 0. It would appear the bankers are firmly in charge of Europe now and have no intention of playing the patsy. The banks were given an incentive to buy sovereign debt under the Basel committee rules that essentially made all European sovereign debt risk free. Banks could own European sovereign debt – no matter the country of issuance – without having to reserve for potential defaults. Europe’s governments, having fixed the rules to ensure a market for the bonds to fund their welfare states, now want to renege – and the bankers are having none of it.

    Don’t get me wrong, Europe’s banks were given a free ride in the run up to the Euro (remember the convergence trade?) and have no one to blame but themselves for loading up on dodgy PIIGS debt but there was an implicit guarantee in the Basel rules that Europe’s governments must now honor. It is not much different than the situation in the US with Fannie Mae and Freddie Mac whose debts are now being honored by the US government. Europe’s governments got the benefit of issuing large amounts of “risk free” debt and now the bill has come due. Germany benefited from this arrangement every bit as much as their southern neighbors by exporting to the artificially supported PIIGS. Punishing the banks for doing their bidding – no matter how satisfying that might be – would reduce the ability of all European governments – including Germany – to borrow in the future.

    What is happening in Europe right now is a contest to see who pays the bill for decades of government overspending (sound familiar?). The private banks want Germany to find a way force the PIIGS to pay up or allow the ECB to enter the market in force to push up the prices of the bonds they already hold. The bankers at the ECB are resisting until they can be sure the PIIGS have budgets in place that ensure the bonds can eventually be honored. The PIIGS – and the rest of Europe’s governments for that matter – want to carry on as they always have but that ship has sailed. These profligate governments are facing a diminution of their power that will be accomplished voluntarily by reducing their citizens promised benefits or by giving up control of their budgets to the Germans through the EU. The bankers are merely forcing the issue to resolution sooner rather than later and Germany is now furiously trying to find a way to enforce EU wide fiscal discipline.

    This is the logical end of the European cradle to grave welfare state. For decades, Europe’s politicians have gained power by granting ever more generous benefits to their citizens as if there was no limit to what they could extract from the private sector economy. With the introduction of the Euro, countries such as Greece, Italy, Portugal and Spain were given a one time opportunity to get their fiscal houses in order. Riding on Germany’s coat tails they should have used the intervening years of falling interest rates to reform their social safety nets to something sustainable. Instead they took the lower interest rates as a signal that they could postpone the needed reforms until…well, until now.

    Whether the Euro holds together or not cannot be predicted, but Europe’s unique brand of “market socialism” has failed. The overly generous promises of generations of politicians will have to be scaled back no matter how the crisis is resolved. It may be in the form of a much weaker Euro or it may be in the form of “austerity” but the current situation is unsustainable for much longer. It appears the bankers – private and at the ECB – have the upper hand and the governments of Europe will be forced to downsize. Europe and the global economy will be better for it in the long run despite whatever short term pain is involved.

    This should also serve as a warning to US politicians. We face our own unsustainable benefit programs and eventually the market will force change upon us as well. Earlier this year, Dallas Fed President Richard Fisher described QE II as a bridge to fiscal sanity. Unfortunately, our politicians chose a fiscal Chappaquiddick and it will now be at least another year before any real reform is possible – assuming our bankers don’t force the issue sooner.

    Tags: Germany, Euro
    Nov 28 10:21 AM | Link | Comment!
  • Some Investors Are More Equal Than Others

    From the WSJ:

    Hours after an Aug. 15 meeting with Federal Reserve Chairman Ben Bernanke in his office, Nancy Lazar made a hasty call to investor clients: The Fed was dusting off an obscure 1960s-era strategy known as Operation Twist.

    The news pointed to a boom in long-term bonds.

    It was a good call. Over the next five weeks, prices on 10-year Treasury bonds soared, offering double-digit returns in an otherwise dismal year.

    By the time the Fed announced its $400 billion Operation Twist on Sept. 21, the window for quick profits had all but slammed shut.

    Ms. Lazar is among a group of well-connected investors and analysts with access to top Federal Reserve officials who give them a chance at early clues to the central bank’s next policy moves, according to interviews and hundreds of pages of documents obtained by The Wall Street Journal through open records searches. Ms. Lazar, an economist with International Strategy & Investment Group Inc., wouldn’t comment for this article.

    Well, I am shocked.

    The Fed justifies these meetings by saying that they “want to know how investors will react to changes in monetary policy so they don’t surprise the market.”  Well, some of the market anyway. The real problem is that Fed policy is subjective rather than rules based. A rules based system – whatever the rule – would allow all market participants an equal opportunity to react to expected changes in Fed policy. Whether the rule was to target a price of gold or an NGDP target, everyone would know when Fed action was required and what form it would likely take. Of course, Laurence Meyer wouldn’t be able to make millions selling research based on access to his former employer but I’m sure he’d be willing to make that sacrifice for the good of the country. Besides, with his considerable skills he could surely find another government teat to suckle.

    Nov 23 2:14 PM | Link | Comment!
  • Is It Time To Buy Like Buffett?

    I write these weekly commentaries to keep our clients and other readers up to date on the current state of the markets and economy. As such, they tend to concentrate on the short term ebb and flow of the economic data and the markets. Current events do have an effect on the market in the short term – and sometimes the long term – and it is prudent to stay aware of the current state of affairs. Trading opportunities often arise from these short term events and I try to take advantage of them both when I can and when they don’t conflict with the long term goals of our clients. Investing, in contrast to trading, however, is a long term endeavor, and when viewed through a long lens, the week to week movements of the market and the economy are less important.

    So this week, rather than review the most recent goings-on in Brussels and DC – which may have an impact in the short term – I want to concentrate on the bigger, long term picture. With the 24 hour news cycle it is hard to escape the “short termism” that permeates our society, but I believe long term investors would be well served by turning off CNBC and walking away from the internet for a while to get some perspective. For long term investors, intelligent decisions made today could have a significant impact on their financial well being decades into the future. Fortunes are – and have been – made through long term investments bought during secular bear markets. In fact, the most successful investor of our time, Warren Buffett, made his fortune (well, made his fortune much larger) doing exactly that during the 1970s. And it appears he is trying to repeat the trick.

    Buffett revealed last week that he had made a significant investment in IBM (which by the way, we have owned in our Global Opportunities portfolio for a couple of years; it’s nice to see Mr. Buffet agrees with our analysis) and several other companies. Buffett invested more of Berkshire Hathaway’s cash in the third quarter of this year than he has in at least 15 years. On August 8th, just after the US credit rating was downgraded and the market was in the midst of a 6% selloff, Buffett bought more stock than he did any other single day this year. In stark contrast, as Buffett was buying during the third quarter, mutual fund investors were selling stocks. According to Lipper, stock and mixed equity funds saw redemptions of $99 billion dollars in the third quarter. If you were a seller in the third quarter, the man on the other side of your trade was Warren Buffett. How does that make you feel about your decision?

    Warren Buffett claims not to be a market timer, but what he really means by that is that he is a disciplined investor. In contrast to mutual fund managers who have to stay fully invested, Buffett only buys when he finds compelling investments. By applying a rigorous value process and only buying when things are cheap, Buffett’s track record reveals him to be one of the best market timers of all time. Buffett dissolved his investment partnership in 1970 saying he found nothing worth buying, and instead took control of Berkshire Hathaway. After the market crash in 1973-74 and then through the rest of the 1970s, Buffett bought many of the stocks that eventually made him a billionaire, including GEICO,  Washington Post and ABC. I would just note here that the 1970s had a degree of economic turmoil.

    Buffett continued buying in the ’80s, making his investments in Coca Cola and Gillette, among others. By the ’90s though with the dot-com boom in full swing, articles started to appear declaring that Buffett was an investing dinosaur and “didn’t get it”. He was accumulating cash and found little worth buying. In 1999, he gave a speech at Sun Valley where he told the assembled crowd that there was no new paradigm and the next 17 years might just look a lot like the 17 year period from 1964 to 1981; in other words a new secular bear market. The man who “didn’t get it” would appear to still have few things on the ball.

    Now Buffett has come full circle and is finding plenty to buy nearly 12 years into a secular bear market. If 2008-09 was akin to 1973-74 then we might still be a few years from a new secular bull market, but for long term investors that shouldn’t matter. Now is when bargains are available and whether the market recognizes that fact soon or in a few years is irrelevant. Globally, blue chip companies of the kind Warren Buffett was buying in the ’70s and today are cheap. I know that is a bit controversial to say and there is a lively debate right now about whether the market is cheap or dear but if one of the greatest value investors of all time is finding bargains, it might behoove investors to figure out what he sees that everyone else doesn’t.

    There are many ways to view market valuations just as there are to value individual companies. One of the more popular methods is Robert Shiller’s Cyclically Adjusted Price to Earnings Ratio which uses an average of 10 years worth of earnings to smooth out the ups and downs of the business cycle. Shiller’s method is not unique or even a new idea (as I’m sure Shiller would acknowledge). In fact, Benjamin Graham, who was Warren Buffett’s mentor and guru, used a similar method of valuing the market. This method currently says rather emphatically that the market is overvalued with a CAPE of around 20. Why, then, if a method of valuation preferred by his mentor is flashing warning signs, is Warren Buffett buying stocks in large quantities?

    I think there are potentially two answers to that question. First, Warren Buffett is not buying the market, and you don’t have to either. Buffett is analyzing individual companies and buying stocks that he believes will offer an acceptable rate of return over the long term. And long term to Buffett is very long term. He still owns the Coca Cola he bought in 1988 and the Washington Post he bought in the 70s. Second, the Shiller CAPE is interesting but the 10 year time frame is basically arbitrary. Business cycles vary in length due to a wide variety of factors and this one is particularly hard to analyze. In addition, the reported earnings used in the calculation for 2008 and 2009 seem somewhat anomalous. In previous bear market episodes the drop in real earnings and dividends were of similar magnitude but the drop in earnings during this crisis far exceeded the drop in dividends. If dividends are a better indicator of what really happened – and remember dividends are paid in cash – then the Shiller CAPE is quite a bit lower than it appears.

    Warren Buffett paid about 12 times earnings for IBM, a company growing at nearly 10%/year. They have consistently raised the dividend and have a large stock buyback program that has reduced shares outstanding by over 30% during the last 10 years. As Buffett pointed out, the company’s business is growing at double digit rates in over 40 countries and has plenty of room for growth in emerging markets. Obviously, the company will be affected if the global economy falls back into recession or something worse but like Buffett, I am fairly optimistic about the long term future of a world that continues to trend toward more freedom.

    There are a lot of problems facing the global economy today, just as there were in 1974, the last time Warren Buffett went on a buying spree. We’ll probably find out this week that a bipartisan committee tasked with coming up with a plan to reduce the US deficit has failed miserably. Most of Europe is a mess and if we don’t get our house in order soon, we’ll be facing a similar situation. China and other emerging market economies appear to be slowing. In addition to the growth worries, central banks are creating the fuel for a future inflation of unknown, but probably large, magnitude. Just to add some geopolitical spice to the story, the Arab world is in the throes of revolution and Iran seems intent on building nuclear weapons. All that is true, and yet Warren Buffett is buying anyway.

    The problems facing the world in 1974 were different but just as scary. Inflation and interest rates were high and rising. The Soviet Union was still a force in the world and Mutually Assured Destruction was the only thing thought to stand in the way of nuclear war. The Middle East was, as it is today, a complete mess. We had a hapless President who would be replaced by an even more hapless one (some things never change). Unemployment would hit 9% in 1975 and finally peak in double digits in the early 80s. And yet, the investments Warren Buffett made during that time propelled him to the top of the Forbes 400.

    I don’t know how all the problems of the world will be resolved and neither does Warren Buffett. But investing is about making rational decisions based on what is known. Right now, US Treasury yields are less than inflation across the maturity spectrum and so offer an assured loss in real terms. The only way an investment there makes sense is if the world enters a deflationary depression. High quality corporate bonds offer only a mild pick up in yield over Treasuries. Junk bonds have higher yields but much higher risk. REITs offer yields that are less than half their long term average. Gold has already risen from $250 ten years ago to $1700 today. Meanwhile, IBM’s earnings yield – the inverse of P/E – is roughly the same as a junk bond. Given that information, the decision for a long term investor – especially a young one – is pretty easy. It’s time to buy like Buffett.

    Nov 21 1:56 PM | Link | Comment!
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