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Todd Kenyon, CFA
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Todd Kenyon PhD CFA has been working as an analyst and portfolio manager for 13 years, and currently presides over a long-only asset management firm, which he founded in 2006. He specializes in uncovering value and exploiting behavioral inefficiencies in the market, typically with a long-term... More
  • The Fed's Misguided Search for Instant Gratification
    Bernanke has admitted that QE2 is intended to prop up the equity markets, resulting in a "virtuous circle" of asset appreciation. This is frankly astounding to me, as it clearly is to many overseas finance ministers. When has the Fed EVER been successful in creating "virtuous" asset value expansion? Once they begin manipulating asset values, you can be certain a bubble will follow.

    This is the same Fed that claims it is impossible to know when a bubble exists. Yet they are clearly trying to precipitate yet another one so soon after the spectacular implosion of their last creation, the real estate bubble. Dylan Grice, Soc Gen's uncommonly rational equity strategist and ardent believer in both value and psychology's influences on the market, summed it up well in his recent installment of "Popular Delusions":
    Humans innovate. The economy grows ...  and all, until very recently, without QE! Maybe someone should tell our central bankers? I’'m not sure why, but they seem to think that the economy only grows because they stimulate it. Economy not growing fast enough? Stock prices not high enough? Consumers not confident enough? Households saving of all things? Why, it can only mean one thing – - we’re not stimulating hard enough!

    Why is it that the central bankers who lecture the world on the efficiency of the market mechanism to set prices don'’t trust that same mechanism to efficiently set the economy'’s cost of capital?

    Amen!! Bond bubble? Check! Commodity bubble? Looming! Equity bubble? Stay tuned!

    The Fed has clearly annoyed the heck out of just about every other functioning economy in the world. The Media was full of quotes, Op-Eds and interviews clearly demonstrating that our overseas friends are none too amused by the Fed printing even more boatloads of money when it clearly isn't needed. If this was the right thing to do, I might not care too much what they think, but banks are flush with liquidity. Our economy is NOT liquidity constrained. But meanwhile the Fed decides to print more in an effort to manipulate the stock market upwards and make consumers feel better about themselves. Who cares if they start a trade war, as long as Mr. Market is happy IN THE NEAR TERM?

    I can't see how this is any more than a short term binge that ends quickly and badly. John Hussman calculated that even if Mr. Market drove the economy (and not the other way around), history shows that a 10% market rally only "results" in incremental economic growth of less than one half of one percent over two years (and then followed, by the way, by a decline that wipes out this "benefit").

    One of Buffett's mantras is that one should always stick to what they know, stay within their circle of competence. This is lost on Bernanke. In his Washington Post Op-Ed he states that the Fed is charged with promoting a "high rate of employment and low, stable inflation". So how does this include inflating asset prices and manipulating markets? Bernanke even says that the 2% inflation rate is "a bit below" the Fed's preferred rate. How does that justify even more "stimulus" in the face of already historically low interest rates and massive dollar debasement?

    It's the unemployment rate silly! Clearly the Fed thinks that blowing dollar bills up Mr. Market's skirt will result in more jobs. As spurious as this logic is, the real problem is that the high employment rates of last decade were a mere illusion also created by the Fed. The jobs created by the real estate bubble - construction, finance, retail, real estate, etc etc, are not coming back any time soon - they never should have existed in the first place. The Fed's last experiment in market manipulation pulled back years and years of future job growth into a short boom period, only to have it spectacularly implode. Add to this the fact that our county is undergoing a permanent structural shift in economic activity. Most basic manufacturing jobs are not coming back - ever. So until we are able to shift to new industries, and create workers with new skills, no amount of funny money will bring back these jobs.

    Even so, the Fed should sit back and let the economy work. It should keep its hands out of the markets. It has done more than enough.  Commodity inflation is as clear as the beard on Bernanke's face, even if "core" CPI numbers tell the Fed that inflation is a "bit low". If this real world commodity inflation gathers some steam, which seems likely as a consequence of QE2, I can't imagine how it has a positive effect on the economy.

    Yet, against this lovely backdrop, Mr. Market is getting giddier by the day. Why? Because Ben told him to! After all, you can't fight the Fed. Until you can - its just hard to tell when that moment will arrive.

    As a value investor, these are the times that try my soul. The bargains available only months ago are largely gone. Most stocks appear fairly to overvalued. My gut says we are WAY overdue for a serious correction. But there is a good chance the market will run through year end. I have some cash in my portfolios, and I have been trimming positions with high weights and/or high valuations. So my cash slowly grows. I am not a market timer, just a value guy, and my valuations are telling me this is what I should do now. I am not the kind to go completely to cash based on my gut or my models. I prefer to hold as long as possible and stay as fully invested as possible, but I won't commit cash to new investments if valuations are unappealing - even if Mr. Market looks to be setting himself up for a holiday binge.

    Hey - if you or I were able to manipulate financial markets and print money, we'd wind up in jail.

    Disclosure: No Positions
    Nov 08 7:10 PM | Link | Comment!
  • The Roots of All Our Problems: Misaligned Incentives
    If you aren't a clueless blue-eyed optimist, or someone simply looking for the next handout, you probably have the same sick feeling deep in your gut that I do. It's an extremely difficult time to be an investor. We could be looking at an economic mess of historic proportions. Yet, the market sits at levels first seen more than 11 years ago, and revisited several times since. So as a value investor, it seems fairly likely that there SHOULD be some bargains out there. Unless the market was ludicrously overvalued 11 years ago (it was obviously). But was it in late 2003 when it once again ascended through the big 10k? That was almost 7 years ago and here we are again.

    These potentially interesting valuations (more on this later) unfortunately rest upon a particularly sickening backdrop. Hey, I'll be one of the first guys to whip out Buffett et al. quotes about how you don't find bargains in a happy place. But this place we are in, and will be in going forward, may be something particularly awful and destructive.

    So just what are the roots of all our problems? Failing Euro economies, a close brush with the collapse of the world's financial markets, the housing bubble, The freakishly horrifying circus in Washington? etc etc?

    Misaligned incentives. End of story. See Munger's speech on this. Read Cialdini's Influence. The whole world goes round based on what psychologists call reinforcement, or economists call incentives. And unfortunately most of our political and financial systems rest upon a foundation of misaligned incentives.

    Let's start on Capitol Hill (hold your nose). Whatever your view of BP and the spill, the hearing with Hayward was simply disgusting. Not one of the self-important pandering boobs asked Hayward what could be done, in good faith, to move the cleanup effort forward as quickly and efficiently as possible. In other words, how could the Government, in the interest of the Gulf and its residents, help to solve the problem? Unless I missed it when I took a break to wretch. Don't think I did though. Instead they focused on backwards-looking finger pointing, name calling, belittling, and grand standing. Good lord, the President - THE PRESIDENT - states he's trying to find out whose a## to kick instead of demonstrating leadership with regard to how the federal government plans to help remedy this mess. All easily explainable by the fact that these goons are ruled by the desire to get re-elected - for its own sake or for THEIR own sake, not because of some honorable desire to do the right thing and serve their fellow man. It's all about keeping their egos inflated, about "winning". And hence, they are incentivized to pander to the majority of the population with an average 7th grade intelligence and maturity level. That's where the numbers are, that's where the votes come from. Must push those buttons. Heck Obama's Oval Office address was criticized for being 9th-grade level. Shoulda been 7th-grade said the analysts. Too many big words and long sentences. Probably why he chose "a##" over "derriere"...

    Let's not forget that humans are not rational - they are rationalizers. They are biologically and evolutionarily pre-disposed to short-termism and herding. We want what feels good NOW, and things feel even better when everyone else is doing them. When we roamed the plains barefoot in pursuit of prey, this served us well since we constantly needed to worry about staying alive, this second. Most people are still bound by this caveman thinking. One reason most of us are terrible investors and make terrible economic mistakes. Let's face it - much of the "science" of economics is based on entirely false assumptions - that humans are rational and always look to maximize economic benefit. FALSE. With relatively few exceptions, they look for the quick fix.

    Just like your average junky or rat in a Skinner cage pressing the bar to get a food pellet or hit of cocaine, we want that feel-good rush of adrenaline and dopamine. Denizens of several Euro countries are entitlement junkies. They've been conditioned to be so by gutless "leaders" who must pander to the junkies to stay in office.

    Wall Street? Exists solely for its own benefit. The players are incentivized simply to make more money, to have a bigger house than the guy next to them at the desk. How much is enough? There is no such thing as "enough" when everyone strives to have more than the next guy. Forget about "serving" investors, or creating free-flowing capital markets. Where is the incentive to do that? Much more money is made by ripping off naive investors and feeding on and/or manipulating the capital markets.

    I could go on and on, but the point is that until people have a reason to "do the right thing", they won't. This scares me. There are some pretty cheap-looking stocks out there. And in fact I plan on starting a series of analyses on some of them, right here. But if the morass of entitlement thinking and childish punitive and backwards-looking actions continue, maybe all bets are off. Somehow America always seems to dig itself out, and you have to believe that we can once again. But something has to change. In the past it has taken wars to wake everyone up, at least for a while. Hopefully we can somehow turn things this time without that kind of unifying event. But something will have to change - big time.

    Disclosure: Long BP
    Jun 28 12:53 PM | Link | Comment!
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