Wednesday, December 31, 2008

Two Year-End Charitable Donation Ideas

Here are two ideas, in the event you're thinking of making a tax-deductible charitable donation for 2008 and don't have a particular charity in mind:

- Spirit of America. Spirit of America fulfills requests for humanitarian aid for locals from U.S. military personnel operating in Afghanistan, Iraq, and Africa. Some examples have included the provision of wheelchairs for Afghan victims of landmines, water purification technology for Iraqi villages, and solar-powered lanterns for Senegalese. I had the pleasure of meeting Jim Hake, the tech entrepreneur who founded Spirit of America, a few years ago in New York, when he brought with him a couple of Iraqi bloggers (the brothers Omar and Mohammed) he had been working with on a project. What Jim has accomplished with SoA has been impressive. I've also had a chance to meet a couple of Marine officers who have been at the pointy end of the spear, implementing projects with SoA, and what those folks have done has been impressive as well.

- The Business Council for Peace. Bpeace supports women entrepreneurs in Afghanistan and Rwanda. Recall that in a recent post ("Questioning the Conventional Wisdom about the Benefits of Microfinance and Encouraging Entrepreneurship") we noted Professor Bateman's criticism of microfinance, that it funds small, "30 chicken farm" types of businesses at the expense of the sort of small and medium businesses that produce more jobs and economic growth. We also noted Scott Shane's similar criticism of American policies that encourage entrepreneurship without discriminating among those entrepreneurs with the best potential to build sustainable businesses. I suspect Professor Bateman and Mr. Shane might approve of Bpeace's approach, which is to identify and vet the "fast runners" (entrepreneurs with the best chance of building sustainable small and medium sized businesses) and back them. The graphic above, from Bpeace's website, summarizes the charity's approach. Incidentally, if you are a businesswoman, getting involved with Bpeace could put you in contact with the sort of successful American businesswomen it could be helpful to know. If you can do well while doing good, all the better.

I hope everyone reading this has a Happy New Year.

Tuesday, December 30, 2008

The Hipster Premium

An article in last weekend's New York Times Real Estate section ("The Sell: Getting New Buyers Into the Pool") described the sale of a 590-square-foot one-bedroom co-op in a 120 year old building (pictured nearby) in the Williamsburg section of Brooklyn. The sale price? $450,000. According to the article, the couple that bought this co-op (pictured above) previously lived on Staten Island and had a 90 minute commute. Presumably, they worked in Midtown Manhattan (or higher up), since Downtown would be a fairly short commute via ferry from Staten Island. If that's the case, they could have had shortened their commute by moving to Hackensack, where $450k would have bought them a 1600-square-foot two-bedroom condo in a new construction building (or a house). Hackensack lacks the hipster cachet of Williamsburg though.

That hipster cachet of Williamsburg and similar Brooklyn neighborhoods is a fairly recent phenomenon. Mark Steyn's obituary for Betty Comden in last year's Atlantic ("Opting for Wit Over Sincerity") was a reminder of that. From Steyn's piece:

...Betty was a starry-eyed hick just arrived in the glittering metropolis from her dusty one-horse rural flag stop: Brooklyn. “Arriving in Manhattan from Brooklyn,” she wrote, “I felt like a kid from a small town, clutching her straw suitcases, and staring up at the Big Town for the first time. It was madly glamorous.”

It stayed that way. Comden and Green never tired of writing screen and stage valentines to “New York, New York / A helluva town”—by which they meant Manhattan. “The Bronx is up / And the Battery’s down”—and Brooklyn isn’t even on the map. As the predatory lady cab driver says to the sailors on the lam in On the Town (1944),

“I know a place across the Brooklyn Bridge where they’ll never find us.”



"Foundations of Crisis"

John Mauldin's website features an essay his friend Doug Casey originally wrote in 1997, "Foundations of Crisis", updated with some current parenthetical commentary by Casey. Those who are open to the possibility that there may be recurring patterns in history may find this an interesting read. Below are a few excerpts.

Casey writes that generations cycle through four archetypes, "Hero", "Artist", "Prophet", and "Nomad". The two excerpts below relate to the "Hero" archetype.

Hero Archetype

The "GI" generation, born between 1901 and 1924, includes basically all living people in their mid-70s and older. They grew up and came of age in the midst of the most traumatic years in human history: the 1930s and '40s. This was a time of catastrophic financial and economic collapse, world war, political dictatorship, genocide, and virulent ideology, among other unpleasant things; a period of intense turmoil. The times required them to be civic minded, optimistic, regular guys who could be counted on to do the right thing, fit in, and see that everybody got a square deal. As a consequence of what they've been through, they tend to be indulgent parents. As kids they're "good"; as adults they're selfless, constructive, and communitarian. Hero archetypes encounter a Crisis environment in Young Adulthood; assuming they survive it, the odds are the rest of their lives will be lived in growing economic prosperity, leading to a leisurely retirement.


The kids born between 1982 and perhaps 2002 should be another Hero archetype. My own experience with them is that they're shaping up that way. Represented by clean-cut, straight-arrow Power Rangers. Quite a reaction to the sewer-dwelling Mutant Ninja Turtles that were analogs for the previous generation. They're "'can do" kids, programmed to do the right thing in a smoke-free, drug-free, eco-sensitive, politically correct world. Like all Hero types, they respect their elders, do what they're told without much questioning authority. That's just the type of person you want to have fighting a war for you, and that's probably just what they'll wind up doing. Just like the last Hero types, the GIs.

Casey on the Boomers, who he characterizes as part of the "Prophet" archetype:

They came of age during a period that might be called an Awakening, and it's recurred on schedule five times so far in American history. Awakenings are times of religious and moral ferment, when the youth tend to challenge prevailing cultural values pretty much across the board. Young adults were into New Age things this time around, in the 1960s and '70s. At the time it seemed utterly shocking and completely new, but that was only because nobody then alive had seen the previous Utopian Awakening in the 1830s and '40s, the Pietist Awakening of the 1740s and '50s, the Puritan Awakening of the 1630s and '40s, or the Protestant Reformation of the 1530s and '40s.


The Boomers are an archetypal Prophet generation, a type born after a secular crisis, just in time to create another one. Get the image of a grim elder, with a well-defined vision of what's right and wrong, calling down wrath, and laying down the law for a troubled nation in chaotic times. That's the type of person who tends to lead countries into wars, as well as through them. Interestingly, the Boomers in America have their counterparts abroad today, especially in China, where they grew up during the Cultural Revolution. Two ideologically driven, righteous groups running two such powerful and alien cultures is almost a guaranteed formula for a millennial-sized crisis. Which should appear, coincidentally, sometime shortly after the millennium.

Casey anticipating a secular crisis:

[T]he way the current generations line up relative to historical analogs, an excellent case can be made the U.S. is approaching another time of secular crisis, a Fourth Turning, with an expected due date of 2005 -- seven years from now -- plus or minus a few years in either direction. The Stamp Acts catalyzed the American Revolution, the election of Lincoln catalyzed the Civil War, the Crash of '29 catalyzed the Depression/WW II era. What might precipitate the elements now floating in solution? The answer is, practically any random event that's sufficiently traumatic. Any of the theses of current disaster/action novels and movies will do nicely. Perhaps the accidental or intentional release of a super plague vector. The crashing of an airliner into the Capitol during a joint session. (Close, but not quite.) An all-out assault on the IRS computers by an armed group -- or perhaps the computers just melting down due to the Year 2000 Problem. Perhaps a financial disaster that cascades into the Greater Depression. In any of these, or a hundred other scenarios, the federal government would almost certainly act precipitously and with a heavy hand, which would bring on a whole other set of consequences.


There's no way of telling where the Crisis will lead, or how it will end. That's going to depend not only on exactly who's in control, but what they do, whom they're up against, and a hundred other variables we can't even anticipate. One thing that seems certain is that real crisis brings out strong (although not necessarily wise) leadership. Because of its age and size, it will come from the Boomer generation, and it will be in the mold of Roosevelt or Lincoln -- both very dangerous precedents. The Boomers in Elderhood will be dogmatic, harsh, puritanical, and quite willing to burn down the barn in order to destroy whatever rats they see. Admix that attitude to a time resembling the Revolution, the Civil War, or WW II, overlain with today's ethnic strife, urbanization, financial overextension, and powerful, compact new weaponry in the hands of foreign fanatics out to teach the Great Satan a lesson, and it's a real witch's brew.

Monday, December 29, 2008

Samuel Huntington Passes Away

Harvard Political Scientist Samuel Huntington passed away last week at the age of 81. Prompted by his passing, RealClearPolitics links to a reprint of Huntington's famously prescient Foreign Affairs essay from 1993, The Clash of Civilizations. In 1996, Huntington published a book expanded from that article, "The Clash of Civilizations and the Remaking of the World Order". In an Atantic article on Huntington from 2001 ("Looking the World in the Eye" -- the Atlantic re-posted this on its website in response to the news of Huntington's passing), Robert Kaplan summarizes some of the themes of this book:

In the book that emerged from his article, The Clash of Civilizations and the Remaking of World Order (1996), Huntington offered a wealth of other insights. He showed that whereas the West has generated ideologies, the East has generated religions—and explained that religion is now the more menacing force on the international scene. He pointed out, counterintuitively, that because communism was a Central European ideology, the Soviet Union was philosophically closer to the West than is the Eastern Orthodox Russia that has succeeded it. He reminded us that the Cold War was a fleeting event compared with the age-old struggle between the West and Islam. In the Middle Ages, Muslim armies advanced through Iberia as far as France, and through the Balkans as far as the gates of Vienna. A similar process of advance, demographically rather than militarily, is now under way in Europe. "The dangerous clashes of the future," Huntington wrote, "are likely to arise from the interaction of Western arrogance, Islamic intolerance, and Sinic [Chinese] assertiveness."

The rest of Kaplan's article is worth reading.

Neither RealClearPolitics nor The Atlantic mentions an article Huntington wrote for Foreign Policy in 2004, "The Hispanic Challenge". In his preface to that article, Huntington wrote:

The persistent inflow of Hispanic immigrants threatens to divide the United States into two peoples, two cultures, and two languages. Unlike past immigrant groups, Mexicans and other Latinos have not assimilated into mainstream U.S. culture, forming instead their own political and linguistic enclaves—from Los Angeles to Miami—and rejecting the Anglo-Protestant1 values that built the American dream. The United States ignores this challenge at its peril.

1On the first page of this essay, Huntington elaborates:

Would the United States be the country that it has been and that it largely remains today if it had been settled in the 17th and 18th centuries not by British Protestants but by French, Spanish, or Portuguese Catholics? The answer is clearly no. It would not be the United States; it would be Quebec, Mexico, or Brazil.

A Brazilian once actually made a similar point to me a few years ago. During a vacation to Brazil I had scheduled a couple of business meetings, the second of which was at the Rio de Janeiro branch of a U.S.-based brokerage. In conversation with the office manager, it came up that a friend and I had visited the old colonial port city of Paraty on our way up from São Paulo. The manager explained the history of the town to me, that it had been the port from which the minerals mined from the Brazilian state of Minas Gerais ("General Mining") were shipped back to Portugal. Then he went on to contrast the difference between the original settlers of what became the U.S. with the original settlers of Brazil: "You had a higher quality of settlers," he said. "Yours -- Puritans -- came to build. Ours came to take". Of course in the 19th and 20th Centuries, Brazil attracted some of the same sort of immigrants that the U.S. did, including Italians, Poles, Germans, Jews, and Japanese (Brazil today has the largest ethnic Japanese population outside of Japan).

"Great Moments in Landlord/Tenant Relations"

A post by Megan McCardle on her Atlantic blog about her D.C. rental market travails prompted this comment from commenter "TallDave":

Pity you're not in southern Wisconsin. I'd gladly rent you a beautiful little 1900 sq ft townhouse I've been advertising for a couple months -- and, of course, you'd get my special libertarian discount.

Instead, I'll just share a "Great Moments in Landlord/Tenant Relations" story I had from a college tax teacher. A friend of her husband's had a nonpaying tenant (an old woman) in an Eastern state where it was very hard to evict people (had to go to court several times, pay a lot of money). After six months of nonpayment, he went to the tenant and told her "Look, I will give you $2,000 to move out." Her reply? "No way, if I move I'll have to start paying rent."

So the landlord is at a bar, telling this story, and there was a guy there who was due to report to prison in a week. He wanted some prison money, and so he offered to get the woman moved out for half what the landlord would have paid the woman, $1000. The landlord agrees (they make no terms as to methods, of course). So the guy breaks into her apartment, tells her she better move, and breaks her arm to prove he's serious; she moves out in terror, he pockets a grand, and the landlord gets a paying tenant.

Is this a classic failure of government regulation, or what?

Saturday, December 27, 2008

Reg T. and Social Security

Regulation T regulates the extension of credit by broker/dealers including the percentage brokerage clients can borrow against their securities in margin accounts. That initial margin is currently set at 50%.

In the late 1990s, when then-Fed Chairman Alan Greenspan spoke about the "irrational exuberance" of stock (and other asset) prices, I wondered why he didn't recommend tightening the margin requirements governed by Reg T in a counter-cyclical fashion. Perhaps the reason he didn't advocate this was because he was wary of trying to determine when asset prices are high due to "irrational exuberance" and when they may be high because fundamentals warrant it. A way around this might be to use average valuation metrics over long periods of time as a guide: for example, market average P/E ratios over the last century, or, to account for earnings cycles, market average P/E 10 ratios (price divided by the average earnings over the previous ten years). Using such metrics, margin requirements could be adjusted on an annual basis, e.g., set at the current 50% when trailing P/E ratios are 15 (about the hundred year average), set at, say, 60% when trailing P/Es rise to 17, and set at, say, 40% when trailing P/Es drop to 13, etc.

That's one idea of a counter-cyclical policy to moderate extreme volatility in asset prices. Another might be to invest part of the Social Security Trust Fund (currently invested in a special class of Treasury securities) in stocks, corporate bonds, or other non-Treasury assets, guided by similar valuation metrics (e.g, new Social Security Trust Fund monies could be invested in stocks only when trailing market average P/Es were below 15). The idea of investing part of the Social Security Trust Fund came up in the late 1990s as well (when market average P/Es were of course much higher, since this was the tail end of the secular bull market in stocks that began in 1982) when it was mooted by the Clinton Administration. At the time, Chairman Greenspan opposed the idea because he worried about the possible negative effects of government intervention in the capital markets, and the idea was never implemented.

I suspected at the time that the real objection to investing part of the temporary Social Security surplus in non-Treasury securities was that it would reduce the amount of money available for the federal government to spend by an equivalent amount (because money invested in Treasury securities is immediately spent by the government), forcing the government to increase its fiscal deficit, restrain spending, or raise taxes. Today, of course, few seem to be worried about increasing the federal deficit, so perhaps now wouldn't be a bad time for the government to invest part of the Trust Fund in stocks.

Getting a Better Cup of Coffee at Starbucks

Next time you go to a Starbucks with a friend, order a "Coffee Press" instead of a drip coffee from one of the big urns. You will pick whichever type of whole beans you want, and the Starbucks folks with grind them and brew them for you in an 8-cup thermal French press like the one shown above. At my local Starbucks this costs $3.50 before tax, which is less than the cost of two "grande" (16 oz) cups of coffee.

A couple of related items:

Two weeks ago, the Financial Times featured an article about Starbucks detailing how Howard Schultz built the business and how he has been dealing with its current challenges, "When the coffee goes cold".

Today, an American history professor made an interesting point in response to that article in a letter to the editor of the Financial Times, "Starbucks is a victim of its own success". The professor's point was that Starbucks introduced people to "the possibility if not the reality of excellent coffee", i.e., it raised the bar for coffee and opened a market for even better coffee served by local coffee shops with which Starbucks can't compete at the high end, and Starbucks has already saturated the market up to the high end (at least in the U.S.: China and other international markets present growth opportunities for Starbucks).

"Madoff Scheme Uncovered"

Hat tip to reader S.L. for this.

Thursday, December 25, 2008

Chain Restaurant Recommendation: Maggiano's Little Italy

The new Hackensack outpost of Maggiano's Little Italy (the facade of which is pictured above) was packed last night when Cheryl and I had dinner there (The Great Depression 2.0 doesn't seem to have hit Bergen County, NJ yet). The only complaint I had when we had dined there last week was that the sponge cake/lady finger part of the tiramisu was a little dry, but it was fine last night. Since Northern New Jersey has a large Italian-American population, there are a lot of local Italian restaurants, but the food at Maggiano's compares favorably with them, and is superior to most of them (granted, some local spots seem to have delegated their cooking to non-Italians). It would be great if the proprietors of some of the sub-par local Italian restaurants had dinner at Maggiano's sometime. The quality of the corporate chain -- Maggiano's is part of Brinker International (NYSE: EAT) -- might shame them into stepping up their games.

Wednesday, December 24, 2008

Christmas in Iceland: Not So Merry This Year

The Financial Times reports on the sad state of Iceland's Christmas season, given the country's banking collapse this year, "Iceland gives Christmas frosty reception".

The photo above, from a related FT slide show, is of a partially built building in a Reykjavik suburb -- a suburb that is likely to remain half-built, according to the FT, due to the collapse in credit availability.

Alloy Steel's Annual Report

Alloy Steel International (OTC BB: AYSI.OB) filed its 10KSB annual report today.

A few notes on it:

- Fiscal 2008 net income was $0.15 per share1, versus $0.08 in 2007, an 87.5% year-over-year increase.

- The company's second mill is completed, and the company expects it to go into commercial production in February.

- The company plans to hire two more manufacturing employees in 2009.

- The company is now looking into the possibility of licensing production of its Arcoplate wear plates in other countries2.

- The balance sheet shows finished goods valued at $765,446. If this represents sales that will be recognized in the next quarter (as was the case with the finished goods that were listed on the 3Q08 10K), and if the company's gross margins remain stable, this could represent approximately $1.4 million in 1Q09 sales.

A more general comment, about the prospects of a "picks & shovels" business such as Alloy Steel's during a steep correction in the prices of mined commodities follows. In a recent article in the Financial Times ("Engineers feel impact of cancelled projects"), the reporter asked the CEO of the British conveyor belt manufacturer Fenner about the impact of the decline in commodity prices. This was the CEO's response:

“Conveyer belts carry materials based on volume and tonnage. If you are producing a commodity, we are driven by volume, not its price,” says Mark Abrahams, chief executive of Fenner.

Of course, if the price of a commodity drops far enough, i.e., below its cost of production, production volume will plummet, but above that price point, a picks & shovels business such as Fenner or Alloy Steel International ought to be less sensitive to fluctuations in price of the underlying commodity.

The photo above, of a truck bed lined with Alloy Steel's wear plate, comes from the Investors Hub page for Alloy Steel.

1This is quite close to a commenter's recent estimate of $0.148, based on the revenue figures in Alloy Steel's last 8K.

2This is a departure from the company's previous position on licensing that we noted in an earlier post ("Answers from Alloy Steel's CFO").

Madoff Made Off With My State Senator's Money

Hat tip to Cheryl for forwarding me this article from Yahoo! Finance, "NJ state senator loses $1.3M life savings". Excerpts from the article:

TRENTON, N.J. (AP) -- New Jersey Sen. Loretta Weinberg's nest egg had grown to about $1.3 million before investments with disgraced Wall Street investor Bernard Madoff wiped her out.

The 73-year-old grandmother believed she was financially secure until recently, when an accountant phoned a relative to say the Weinberg family's investments -- including the senator's and those of many in her family -- were now worth nothing.


"I was shocked first of all," said Weinberg, a Democrat representing Bergen County. "I had never heard of Bernie Madoff. My money was invested, along with many extended family members, with a financial adviser in Los Angeles."

The Weinbergs' money manager, Stanley Chais, had invested his clients' IRAs, 401Ks and other funds with Madoff.


Despite losing her life savings, Weinberg, who makes $49,000 a year as a state legislator, isn't moping.

The liberal lawmaker said she still has the work that she loves and the ability to pay her mortgage.

"I'm really better off than a lot of people around us in our society today," she said. "I may be better off than some of the people who got ripped off in this scandal."

Weinberg's even come up with laugh lines about her predicament.

For example, she's been joking with friends that she's going to earn money by starting a new franchise: Granny's Pizza Delivery. The deliverers will use walkers that have been retrofitted with pizza-warming trays. She laughingly predicts that those grannies, including her, could pull in big tips.

I can't say I've ever voted for the lady, who has been called the most liberal politician in New Jersey (although my father volunteered for her when she was an assemblywoman), but I give her credit for holding onto her sense of humor in the face of this disaster.

The photo above, of Senator Weinberg with President-elect Obama, is from Senator Weinberg's website.

Monday, December 22, 2008

USEG Management Agrees with Commenter J.K.

In a comment on a recent post ("Why We Will Be Using Fossil Fuels for Decades to Come"), commenter J.K. wrote,

Forget wind and solar(-except maybe satellite based), the real next gen energy is geothermal. You don't have to rely on conducive weather conditions or harming the environment. We probably will be using predominantly fossil fuels for the forseable future though. Hopefully not.

U.S. Energy Corp. (Nasdaq: USEG) executives had mentioned on previous occasions that they were considering investments in alternative energy, and today USEG issued a press release announcing that it had invested $3.445 million for a 25% stake in Standard Steam Trust LLC, a privately-held geothermal energy company based in Denver, CO. From the press release,

``After spending considerable time reviewing the renewable energy sector, we firmly believe that our entry into geothermal provides our company with a strong position in a market that has tremendous growth potential,'' said Mark Larsen, President of U.S. Energy Corp. ``Geothermal is a renewable subsurface fuel, and our partners are applying their extensive experience in modern oil and gas plays to geothermal exploration. This sector shows significant promise at a time when carbon management is playing an increasing role in the generation of clean energy in our nation,'' he added.

Since Standard Steam Trust is privately-held, it's hard to speculate on whether USEG paid a fair price for its stake, but it is probably prudent, for political reasons if nothing else, for a diversified natural resources company to position itself as a player in "clean" or "renewable" energy as well. Perhaps this will give USEG some environmental bona fides that will help it somewhat in getting the necessary approvals for its molybdenum mine.

The graphic above, on harnessing geothermal energy, comes from the Seattle Post-Intelligencer.

"The Arab Sole"

Whoever writes the headlines at Forbes, wrote a clever one for Tunku Varadarajan's column today about Muntader-al-Zaidi, the Arab journalist who threw his shoes at President Bush during the President's recent joint press conference in Baghdad with Iraqi Prime Minister al-Maliki, "The Arab Sole". Below is a brief excerpt from Varadarajan's column:

The Arabs, who once upon a time boasted Averroes and Avicenna, are now reduced to eulogizing a boorish act of agitprop as a heroic achievement. America gave us Martin Luther King; South Africa gave us Mandela; India gave us Gandhi; the Arab world gives us ... Muntader-al-Zaidi. A people who invented the zero are now reduced, themselves, to zero. Only a people who live under the boots of their rulers celebrate the throwing of a shoe at a guest.

A commenter on Varadarajan's column on Forbes's website objected that zero was actually invented by the Hindus. According to Scientific American's take on this question, by former Harvard professor of mathematics Robert Kaplan ("What is the origin of zero? How did we indicate nothingness before zero?"),

The first recorded zero appeared in Mesopotamia around 3 B.C. The Mayans invented it independently circa 4 A.D. It was later devised in India in the mid-fifth century, spread to Cambodia near the end of the seventh century, and into China and the Islamic countries at the end of the eighth. Zero reached western Europe in the 12th century.

The symbol changed over time as positional notation (for which zero was crucial), made its way to the Babylonian empire and from there to India, via the Greeks (in whose own culture zero made a late and only occasional appearance; the Romans had no trace of it at all). Arab merchants brought the zero they found in India to the West.

Sunday, December 21, 2008

Questioning the Conventional Wisdom about the Benefits of Microfinance and Encouraging Entrepreneurship

In 2006, Muhammad Yunus and the bank he founded, Grameen Bank, were jointly awarded the Nobel Peace Prize for their work in essentially creating the business of micro-finance, extending small loans to poor Bangladeshis so they could start their own businesses. Micro-finance, due to the typically high interest rates charged and the communal pressure against defaulting (villagers understand that their credit would be put at risk collectively if one of them defaults) has proved quite profitable and has been implemented in various poor countries. Saturday's Financial Times featured a letter to the editor from a visiting professor of economics at the University of Juraj Dobrila Pula in Croatia, Milford Bateman, that contested the conventional wisdom about the benefits of micro-finance, "Microfinance’s ‘iron law’ – local economies reduced to poverty". Below is an excerpt from Professor Bateman's letter:

[I]n nearly 25 years of academic and consulting work in local economic development, my experience is that microfinance programmes most often spell the death of the local economy. Put simply, to the extent that local savings are intermediated through microfinance institutions, the more that country or region or locality will be left behind in a state of poverty and under-development. This is an “iron law of microfinance”. Focusing on isolated cases of microenterprise success simply does not add up to economic development. The reason microfinance is supported is overwhelmingly political/ideological – the economic rationale is simply not there.

I have recently been working as a consultant in Serbia. Here the foreign-owned commercial banks since 2001 have massively discovered microfinance. From almost zero in 2001, the commercial banks now channel 22 per cent of their total loan portfolio through highly profitable microfinance (household microloans) programmes amounting to almost 12 per cent of gross domestic product.

This has had two important results: first, a serious shortage of funds for small and medium-sized enterprises, which is deeply damaging because SMEs have by far the most sustainable growth and development potential. Second, thanks to microfinance there has been an accelerated proliferation of informal-sector microenterprises in Serbia over 2004-08, so the country is now chock-full of traders, kiosks, shops, street-traders and subsistence farms. The base of the economy is quite simply being destroyed.


The East Asian countries managed to develop brilliantly through channelling much, if not most, of their savings into serious growth-oriented sustainable business projects. This is why many east Asian countries may have started at similar GDP levels as Bangladesh in the 1970s but have since then massively outpaced Bangladesh in terms of growth and development. Economics 101 shows conclusively how critical savings are to development, but only if intermediated into growth- and productivity-enhancing projects. If it all goes into rickshaws, kiosks, 30 chicken farms, traders, and so on, then that country simply will not develop and sustainably reduce poverty.

Professor Bateman's letter to the Financial Times brought to mind an article by Scott Shane titled "The Non-Starters" in the current issue of The American. Unfortunately, that article doesn't appear to be available online [Update: it's available now], but Shane's point was somewhat similar to Bateman's, although Shane focused on business in the U.S. Shane wrote that most start-up businesses in America were economically unproductive, created relatively few jobs, and what jobs they did create tended to be lower paying and have fewer benefits than those at larger companies. The reason for this, according to Shane, was that there simply are fewer talented entrepreneurs with high levels of human capital than there are Americans who start small businesses, and that many small businesses are started by unemployed or underemployed individuals who are motivated to do so partly by government incentives (e.g., government small business loans, grants, training and other encouragement) and by the relatively low opportunity costs for them of starting a small business, due to their current employment status.

These unskilled entrepreneurs tend to have high failure rates partly because they have low levels of human capital and partly because they tend to enter over-crowded niches. Scott Shane thought that an appropriate policy response by the U.S. and state governments would be to stop encouraging everyone to become an entrepreneur, and to instead think like a venture capitalist and provide support for those entrepreneurs with more obvious potential. Professor Bateman's point about micro-finance -- that it is supported for political/ideological reasons -- would seem to apply to American policies toward entrepreneurship and small business start-ups.

The photo above, of Dr. Yunus displaying his Nobel Peace Prize, is from the Nobel Foundation's website.

Saturday, December 20, 2008

More on Madoff

In a recent post ("Edelheit on the Madoff Scandal") we quoted Aaron Edelheit's three key points on why investors should have been wary of Madoff's fund. Back in 2005, Harry Markopolous sent the SEC a 21-page letter titled, "The World's Largest Hedge Fund is a Fraud". Below, via, is that letter, in which Markopolous cited 29 red flags relating to Madoff's fund.

Markopolos Madoff Complaint
View SlideShare document or Upload your own. (tags: madoff ponzi)

A Rough Week for KSW

On Monday, shares of HVAC contractor KSW, Inc. (Nasdaq: KSW) dropped from $4.40 to $3.88. The next day, KSW filed an 8-k stating that the 56 Leonard Street Project in downtown Manhattan, the HVAC contract on which was worth $24 million, had been put on hold by the developer (judging from Monday's price action, someone got the memo early).

On Thursday, KSW released another 8-k stating that another project, this one on 42nd Street and 10th Avenue in Manhattan, was being delayed by the developer, who is seeking a redesign to reduce construction costs, and plans to restart the project within three months. The HVAC contract for this project is approximately $32 million. So within a few days, about $56 million of KSW's previously reported backlog of approximately $139 million was put on hold. It appears that the $32 million contract might get reduced somewhat, but that project could be back online in a few months; the $24 million contract appears to be on hold indefinitely.

In the wake of these two negative 8-ks, KSW shares traded as low as $1.79 on Friday, despite the company having no debt and a little over $3 per share in cash. Late Friday, the company released a press release announcing that its board had authorized a share buyback of $1 million, adding that,

“We will retain the repurchased shares as treasury stock,” said Floyd Warkol, Chairman and CEO of KSW, Inc. “We believe that the market’s response to our latest filings is unwarranted based upon the Company’s financial condition and standing in the industry.”

KSW shares recovered somewhat to close at $3.10 after hours.

Had I been following this in real time on Friday, I would have been a buyer when KSW traded below net cash. The near-term outlook for residential and commercial real estate in Manhattan is grim, but the company also does work in sectors that are less economically sensitive (e.g., hospitals, schools, court houses, etc.), and as I noted in a previous post (KSW Update),

The company also could be positioned to benefit if a new economic stimulus package includes funds for local infrastructure projects, since KSW's CEO sits on the Metropolitan Transportation Authority's Blue Ribbon Panel on Construction Excellence which provides "guidance to the MTA as it pursues its ambitious capital construction program" and the New York City Department of Environmental Protection's Blue Ribbon Panel on Construction Costs, which provides "guidance to the DEP on its capital construction program."

The image above, via Luxury Insider is a rendering of the 56 Leonard Street building designed by the Swiss architects Herzog & de Meuron, the same firm that designed the "Bird's Nest" stadium in Beijing. Condos at 56 Leonard were to range in price from $3.5 million to $30 million. There's obviously less demand in that price range now, given the ongoing effects of the deleveraging process on Wall Street.

Thursday, December 18, 2008

Eliot Spitzer in Chinatown; David Paterson on SNL

From John Gapper's Financial Times blog, "Eliot Spitzer shows his face in Chinatown":

If Eliot Spitzer had had to choose a venue at which to make his re-entry into society, he would presumably not have selected a former massage parlour in Chinatown on the Lower East Side of Manhattan.

But Mr Spitzer, who resigned as governor of New York state after getting caught up in a call girl scandal this spring, did not get the choice. Happy Ending, the former parlour in question, is now a sleek bar and it is where Slate, the online magazine was holding its seasonal drinks party.

Mr Spitzer this month week started to write a column for Slate as part of his comeback - he wrote last week about the Detroit bail-out - and so he showed up at the Slate party to be sociable.

The first I knew of it, since I was there last night, was when Mr Spitzer’s familiar face appeared, asking where he could find Jacob Weisberg, Slate Group’s editor-in-chief. I pointed through a crowd of people in his direction.

“Don’t worry,” Mr Spitzer replied cheerfully, starting to make his way through the crowd. “I’ve got sharp elbows.”

I went over afterwards to ask him how he was enjoying life as a columnist. “It sucks,” he said with a grin. “I used to be governor of New York”.

Mr Spitzer presumably knew he was walking into the lion’s den since he was surrounded by journalists, but he was unabashed. I rather admired his chutzpah and his willingness to turn up with just a sense of humour to protect him.

Incidentally, for those who haven't seen this yet, Spitzer's successor as New York Governor, David Paterson, was spoofed on Saturday Night Live last weekend:

Edelheit on the Madoff Scandal

This excerpt is from one of Aaron Edelheit's more informative recent posts, "Negligence and Culpability":

There are three key points that should have stopped people from investing with good ol Bernie:

1)He held custody of his own money. Every financial fraud of recent memory all had one thing in common, the person committing the fraud had possession of the money. There are simply too many conflicts of interest when the person managing the money possesses the money and there are no safeguards.

2)His auditor was a firm no one ever heard of. Not only that but it had three employees, one of whom apparently worked in a tie die shirt for 15 minutes a day. Not only do I have a big name auditor, who is expensive, but I actually have three different accountants from different firms. One is my auditor, one is my administrator and the other approves whenever I, personally, withdraw money. These are all safeguards for investors, so that they know there are procedures and many eyes making sure everything is picture perfect.

3)Abnormal consistency of his returns. As this year shows very clearly, there is simply no way for an investment strategy to show consistent positive returns [Madoff showed a positive return every month, I believe]. There is always something that throws a monkey wrench in it, even for a short period of time and you should be paranoid by someone claiming to never show volatility.

Tuesday, December 16, 2008

Great Name for a Hedge Fund Adviser

From the Financial Times's front pager on the Madoff scandal ("Madoff fallout spreads worldwide"):

“This was the train wreck that happened in broad daylight,” said Jim Hedges, a hedge fund adviser who did not place any investors’ money with Bernard Madoff Investment Securities.

"Why Gasoline is Still King"

Another interesting article from the American re fossil fuels, this one by Ralph Bennett: "Why Gasoline is Still King: Electric roadsters are the darlings of the press, but it is likely that gasoline will continue to dominate personal transportation." Bennett's short answer comes down to the energy density of gasoline. Below is a relevant excerpt:

We may expatiate on the latest developments in electric cars and the delicious prospects of hydrogen fuel cells and various biofuels made with everything from switch grass to garbage; we may earnestly speculate about flywheels and compressed air and various gases, natural and unnatural—but we go with gasoline.

A gallon of gas weighs about 6.3 pounds and produces roughly 35 kilowatt hours of energy. That’s enough to burn a 100-watt light bulb continuously for more than two weeks. A lead-acid battery could do the same thing without needing a recharge—if it were the size of a desk and weighed a ton. Energy density is the point. We just haven’t come up with a fuel or a device that will safely and economically offer the same calorific value in such a small space as an automobile’s gasoline tank. Compressed natural gas (CNG) and liquefied natural gas (LNG) intrigue us, but the problems of storing them (or hydrogen) in a car in sufficient quantity to approach gasoline’s range and performance continues to be a sticking point. We always come back to density.

The photo above, from the article, is of the Tesla Roadster

A Question about the Madoff Scandal

Why confess now? If you're running a Ponzi scheme, and investors are starting to ask for their money back, why not do what other, putatively legitimate, hedge fund firms have done and announce that you are restricting withdrawals for a few months while you sort out illiquid positions? You'd still have the problem that your actual assets are significantly less than what you have claimed, but, again, why the need to confess the scheme? Let's say that the returns you've claimed imply that you have $50 billion in assets under management, but you only have $15 billion. Wouldn't 2008 be a convenient year to blame the difference on suffering catastrophic investment losses?

I guess Madoff's sense of guilt caught up with him, but it seems like an awful year such as this one would be one in which it might be possible to unwind a Ponzi scheme without getting caught.

Monday, December 15, 2008

Why We Will Be Using Fossil Fuels for Decades to Come

From Vaclav Smil's essay in the American, "Moore's Curse and the Great Energy Delusion":

“Energy transitions” encompass the time that elapses between an introduction of a new primary energy source oil, nuclear electricity, wind captured by large turbines) and its rise to claiming a substantial share (20 percent to 30 percent) of the overall market, or even to becoming the single largest contributor or an absolute leader (with more than 50 percent) in national or global energy supply. The term also refers to gradual diffusion of new prime movers, devices that replaced animal and human muscles by converting primary energies into mechanical power that is used to rotate massive turbogenerators producing electricity or to propel fleets of vehicles, ships, and airplanes. There is one thing all energy transitions have in common: they are prolonged affairs that take decades to accomplish, and the greater the scale of prevailing uses and conversions the longer the substitutions will take. The second part of this statement seems to be a truism but it is ignored as often as the first part: otherwise we would not have all those unrealized predicted milestones for new energy so.


The scale of transition needed for electricity generation is perhaps best illustrated by deconstructing Al Gore’s July 2008 proposal to “re-power” America: “Today I challenge our nation to commit to producing 100 percent of our electricity from renewable energy and truly clean carbon-free sources within 10 years. This goal is achievable, affordable, and transformative.”

Let’s see. In 2007 the country had about 870 gigawatts (GW) of electricity-generating capacity in fossil-fueled and nuclear stations, the two nonrenewable forms of generation that Gore wants to replace in their entirety. On average,these thermal power stations are at work about 50 percent of the time and hence they generated about 3.8 PWh (that is, 3.8 x 1015 watt-hours) of electricity in 2007. In contrast, wind turbines work on average only about 23 percent of the time, which means that even with all the requisite new high-voltage interconnections, slightly more than two units of wind-generating capacity would be needed to replace a unit in coal, gas, oil, and nuclear plants. And even if such an enormous capacity addition—in excess of 1,000 GW—could be accomplished in a single decade (since the year 2000, actual additions in all plants have averaged less than 30 GW/year!), the financial cost would be enormous: it would mean writing off the entire fossil-fuel and nuclear generation industry, an enterprise whose power plants alone have a replacement value of at least $1.5 trillion (assuming at least $1,700/installed kW), and spending at least $2.5 trillion to build the new capacity.

But because those new plants would have to be in areas that are not currently linked with high-voltage (HV)transmission lines to major consumption centers (wind from the Great Plains to the East and West coasts,photovoltaic solar from the Southwest to the rest of the country), that proposal would also require a rewiring of the country. Limited transmission capacity to move electricity eastward and westward from what is to be the new power center in the Southwest, Texas, and the Midwest is already delaying new wind projects even as wind generates less than 1 percent of all electricity. The United States has about 165,000 miles of HV lines, and at least 40,000 additional miles of new high-capacity lines would be needed to rewire the nation, at a cost of close to $100 billion. And the costs are bound to escalate, because the regulatory approval process required before beginning a new line construction can take many years. To think that the United States can install in 10 years wind and solar generating capacity equivalent to that of thermal power plants that took nearly 60 years to construct is delusional.

The Small World of Chicago Elites

Yesterday's New York Times featured a profile of Desirée Rogers (the woman in the center in the nearby photo1), who will be President-elect Obama's White House social secretary ("Atop Capital's Guest Lists, an Outsider"). Ms. Rogers, a former executive at a Chicago-area utility and at Allstate Financial, is the ex-wife of John W. Rogers, Jr., the portfolio manager and founder of Ariel Investments. The article notes that John W. Rogers played basketball at Princeton with Craig Robinson, Michelle Obama's brother. Rogers is one of the gurus tracked by the GuruFocus website.

1The woman on the right in the photo is Obama confidante Valerie Jarrett, who, according to Wikipedia, was born in Iran, where her father, Dr. James Bowman, was running a children's hospital at the time.

Saturday, December 13, 2008

John Hussman from May 2007

From one of Dr. Hussman's weekly market commentaries in May, 2007, five months before the end of the cyclical bull market that began at the end of 2002 ("How Much Do Interest Rates Affect the Fair Value of Stocks?"):

In recent months, I've used a wide variety of analytical methods (discounted cash flows, normalized earnings, price/peak earnings calculations, etc) to show that stocks are currently priced to deliver unusually poor long-term returns – stated simply, the U.S. stock market is more overvalued than at any point in history except during the late 1990's bubble.

It's worth reading the rest of that column, for Dr. Hussman's skeptical take on the Fed Model, and the conventional wisdom about the relationship between interest rates and stock valuations.

Friday, December 12, 2008

Profiting from the Credit Crisis

Back in August, we mentioned two groups of entrepreneurs that were profiting from the credit crisis ("Profiting from the Credit Crunch/Real Estate Bust"). Yesterday, the Financial Times published an article about another such entrepreneur: Barry Silbert, the founder of SecondMarket. According to the article ("SecondMarket enters new territory"), Silbert started SecondMarket in 2004 to provide a marketplace for trading restricted securities; in the first quarter of 2009, Silbert plans to create an online marketplace for illiquid mortgage-backed securities and CDOs. From the article:

Inspired by books about, Ebay and Goldman Sachs, Mr Silbert says the SecondMarket platform will, for example, allow valuation experts, research providers and others to offer their services and get ranked by users.

"We are incorporating the best of current technology," says Mr Silbert. "We are inspired by the ideas behind the wisdom of crowds, and want to be inclusive rather than exclusive."

SecondMarket is a broker-dealer, getting paid a transaction fee on deals that get done, but not taking any positions itself. With many Wall Street players strapped for cash, no other serious venture aimed at targeting illiquid markets has emerged.

This story about SecondMarket reminds me about the old cliché (apparently untrue, according to this essay by U Penn Chinese professor Victor Mair) that the Chinese word for "opportunity" is comprised of characters meaning "danger" and "opportunity". The characters shown above, from Professor Mair's essay, are the ones that comprise the Chinese word for "crisis", "wēi" and "jī". For Professor Mair's explanation of why "wēi" can be translated as "danger" but "jī" shouldn't be translated as "opportunity", see his essay.

Infinite Connections or Infinite Jest?

Earlier this week, the New York Times reported that laid off investment banker Joshua Persky (the fellow on the right in the photo above) landed a new job several months after becoming famous for handing out resumes in Midtown Manhattan while wearing a sandwich board advertising his job hunt ("After Unusual Hunt, Ex-Banker Lands a Job"). You probably already know that Mr. Persky has landed a new job, since, as Mr. Persky notes on his blog today, his story has been picked up by all sorts of media outlets, including MSNBC, the front page of Yahoo!, etc.

Persky's successful job hunt is an inspiring story of persistence and originality, and that seems to be how most of the media have covered it, but as a cynic, it raises a question for me: What does it say about MIT's alumni network (here is its "Infinite Connections" website) or the prestige of an MIT degree that an MIT alumnus had to resort to such a stunt to find a job? Presumably, one can get an education of similar high-quality at a somewhat less prestigious (and less expensive) school; if the added prestige and connections of an MIT degree are of such little value that an alumnus needs to go to such extraordinary lengths to get a new job, than why pay more to go to MIT?

Thursday, December 11, 2008

Alloy Steel Breaks Radio Silence

Alloy Steel International (OTC BB: AYSI.OB) belatedly filed an 8-k announcing its preliminary full year sales and pre-tax profit (the company's fiscal year ended on September 30th):


The Company advises that its unaudited profit before income tax expense for the financial year ended September 30, 2008 is $3,670,000. This is an increase of $1,710,000 over the profit before income tax expense achieved for the year ended September 30, 2007.

This profit has been achieved on sales of $13,500,000, which is an increase in sales of $4,800,000 over the previous year.

While these figures are still subject to final sign off by the Company's Auditors, the Directors do not believe there will be any significant changes to these figures.

The Company is very cognizant of the possible effects of the economic downturn on the world mining market but believes that, with its positioning in the market place, it will not be adversely affected by the possible change in market conditions.

The last sentence above is encouraging.

After subtracting the sales and pre-tax profits from the first three quarters of this year from these preliminary year-end numbers, we end up with 4Q sales of $3,572,000 and 4Q pre-tax earnings of $1,014,000. My estimate was too high on the profit side and a little low on the revenue side: I estimated the firm would generate about $1.3 million in profits on about $3 million in sales in the quarter. After tax profits might end up being ~$700k for the quarter, but that would still be a significant sequential increase from last quarter's profit of $230k.

I got another limit buy order for Alloy Steel filled at $0.451 yesterday; I have another GTC order open at close to that price, but given this 8-k, I doubt I'll get it filled today.

The image above, which shows how Alloy Steel's Arcoplate wear plates minimize hang up, is from the company's website.

Wednesday, December 10, 2008

Juxtaposition in the Financial Times

There was an interesting juxtaposition in today's Financial Times. Page seven contained an article on commodities with the bearish headline, "So long, super-cycle". The article itself was more balanced than that headline, and included a couple of "to be sure" paragraphs, summarizing the view that the current commodity correction is a cyclical one within an intact secular bull market. The main focus of the article though was on the bearish view, including that of the World Bank, that the commodities boom is over. This article was juxtaposed by these two articles on page six, warning of falling supply of agricultural commodities:

"Crop Crunch: Brazil Farmers lose debt battle", which noted that,

Credit for fertiliser and other inputs has dried up. Soya production in the [Brazilian] state [of Mato Grosso] is likely to fall by 10 per cent this year, farmers say. Next year, it could fall by two-thirds.


"Sharp drop in Argentine wheat output forecast", which noted that,

"Wheat output from Argent­ina, the world’s number four exporter, is set to fall by more than 37 per cent in 2008-09..."

Holman Jenkins's Latest on the Proposed Auto Bailout

From his column in today's Wall Street Journal, "A Bailout that Won't":

Forget Chrysler, which has needed a bailout from Washington or Stuttgart in three of the last four recessions. The tragedy of GM and Ford is that, inside each, are perfectly viable businesses, albeit that have been slowly murdered over 30 years by CAFE. Both have decent global operations. At home, both have successful, profitable businesses selling pickups, SUVs and other larger vehicles to willing consumers, despite having to pay high UAW wages.

All this is dragged down by federal fuel-economy mandates that require them to lose tens of billions making small cars Americans don't want in high-cost UAW factories. Understand something: Ford and GM in Europe successfully sell cars that are small but not cheap. Europeans are willing to pay top dollar for a refined small car that gets excellent mileage, because they face gasoline prices as high as $9. Americans are not Europeans. In the U.S., except during bouts of high gas prices or in the grip of a Prius fad, the small cars that American consumers buy aren't bought for high mileage, but for low sticker prices. And the Big Three, with their high labor costs, cannot deliver as much value in a cheap car as the transplants can.

Jenkins puts his finger on a key problem here. If the government's goal is to get Americans to drive more fuel efficient cars, the way to do that would be to raise federal gas taxes steeply. Then, Americans would effectively be forced to buy smaller, more fuel-efficient cars, and the domestic automakers would be able to sell them the sort of more expensive, higher-margin small cars they successfully sell in Europe. Politically, of course, it's easier for Congress to raise CAFE standards than raise gas taxes.

Tuesday, December 9, 2008

You Pick the Post, Part II

Here are a few more topics I've been considering posting about:

- Chipotle (got a free dinner there last night, incidentally) and its competitors; the niche it and similar upscale fast food chains fill in high cost cities like New York.

- The trouble with Harvard-educated elites: Atlantic editor and Harvard alumnus Ross Douthat thinks its their arrogance; I suspect it's something else.

- That Reg. T post.

- Dealing with Deflation, Part II: The pros and cons of the government borrowing money to buy assets such as corporate bonds, stocks, etc.

- The Fox TV show The Terminator: The Sarah Connor Chronicles.

Monday, December 8, 2008

A Note on KSW

In a post at the end of October ("KSW Update"), I mentioned that the company's general counsel, Jim Oliviero, had mentioned to me that KSW (Nasdaq: KSW) was still keeping an eye out for potential acquisitions. I had that post in mind when I learned recently about a small HVAC company on sale through a business broker. After speaking with the broker, I called Mr. Oliviero last Friday to see if KSW was still exploring potential acquisitions. Oliviero said KSW is not looking for acquisitions right now, and instead, given the uncertainty stemming from the financial crisis, is holding onto its cash, which increases its ability to get bonded for new projects.

The image above, of one of KSW's current projects, the cardiovascular center at New York Presbyterian Hospital, is from KSW's website.

John Hussman's Latest Weekly Market Commentary

In his current market commentary, "Ambiguous Conditions Warrant Moderation", Dr. Hussman gives his opinion on the comparisons of today's economic environment to the Great Depression, finishing with a clever simile:

We continue to hear remarks that the current economic downturn is the worst since the Great Depression. While the prices of stocks and other financial assets have certainly suffered a great deal, by any reasonable measure of output and employment, this isn't even close to being the worst economic downturn since the Depression. Even after November's awful job report, and including all of the downward revisions, the U.S. economy would have to lose twice as many jobs as it has already lost even to be on par with the 1981-82 recession (measuring job losses as a percentage of the labor force).

While we do expect fourth-quarter GDP to come in at a loss of -4% to -6%, it is important to recognize that this is a quarterly change at an annual rate. The overall contraction in U.S. output will be somewhere about 1-1.5% in the fourth quarter. In the Great Depression, actual GDP dropped by 30%. Ben Bernanke was correct in remarks he made last week that there is “an order of magnitude” (10 fold) difference between the current downturn and the Great Depression. For the record, the worst overall drawdowns in GDP since the Depression – not just bad quarterly growth rates – were in 1954 (-2.65%), 1958 (-3.75%), 1975 (-3.10%), and 1982 (-2.87%).

This is not to minimize the prospects for a further economic downturn, but to say that this is “the worst economy since the Great Depression” is like blowing up a crate of dynamite on the Nevada Proving Grounds and saying it is the worst explosion since the detonation of the atomic bomb there. Even if the statement is accurate, the comparison is absurd.

Unlike Bill Gross and John Authers (see "Bill Gross on Stock Valuations"), Hussman does not believe corporate bonds are more attractive than equities at this point:

Corporate yields have increased significantly, but default rates tend to pick up in the later stages of recessions, and there isn't much historical evidence to suggest that corporate bonds reach their lows any earlier than stocks do. For that reason, corporate bonds are essentially equity-equivalents here, and the same considerations about quality apply as well here as they do for stocks. Generally speaking, corporate bonds are currently priced to deliver both lower long-term returns than stocks, but as a group, will probably have lower volatility than stocks as well. Our inclination to invest in corporates for the Total Return Fund will likely increase at about the same time as our willingness to hold stocks on an unhedged basis for Strategic Growth (which is not yet).

Sunday, December 7, 2008

"The Velocity Factor"

In John Mauldin's latest Thoughts from the Frontline newsletter, "The Velocity Factor" (PDF), Mauldin argues that the Federal Reserve "not really expanding the money supply, so far" because the expansionary effects of Federal Reserve actions so far have been offset, to a large extent, by the decrease in the velocity of money as financial innovations that increased velocity (e.g., securitization) are being unwound. Mauldin asks,

How much monetization will be enough to halt deflation and overcome the slowdown in the velocity of money and the rise in personal savings? No one knows. There is no fancy equation or model which can encompass all the factors, or at least not one I know of.

We will also soon see which of the additional deflation-fighting policies that Bernanke outlined in his 2002 "helicopter" speech the Fed will adopt. It is highly likely that we will see more than a few of them. It is quite possible that we will see the Fed start to set rates on longer-term bills and even bonds in an effort to pull down longer-term rates for corporations and individuals.

We will explore all the deflation-fighting options and what the results might be in future letters, but remember that there will come a time when the Fed will have to "take back" some of the liquidity they are going to provide. That means we could be in for a multi-year period of slow growth after we pull out of this recession. And this recession could easily last through 2009.

Here is a link to the 2002 "helicopter" speech by Ben Bernanke that Mauldin referred to above: "Deflation: Making Sure "It" Doesn't Happen Here".

Saturday, December 6, 2008

Bill Gross on the Q Ratio

For commenter Dr. Paul Price, aka Stockdoxc, who prefers to see the glass as half-full, above is the Q Ratio chart from Bill Gross's December Investment Outlook, and below is Gross's explanation of the metric.

I believe in stocks for the long run – but only if purchased at the right price. That statement packs a real punch. It says that capitalism is and will remain a going concern, that risk-taking – over the long run – will be rewarded, but only from a starting price that correctly anticipates the economy’s growth and its share of after-tax corporate profits within it. Acknowledging the above, let’s look at a few basic standards of valuation that historically have stood the test of time, to see if at least the price is right.

One of them is what is known as the “Q” ratio, or the value of the stock market relative to the replacement cost of net assets. The basic logic behind “Q” is that capitalism works. If the “Q” is above 1.0, then the market is valuing a company at more than it costs to reproduce it; stock prices should fall. If it is below 1.0, then stocks are undervalued because new businesses can’t be created at as cheap a price as they can be bought in the open market. In the short run, this ratio is volatile as shown below but it tends to be mean reverting, which is critical. As long as capitalism is a going concern, “Q” should mean revert to 1.0. If so, then oh, oh what a “Q”! Today’s Q ratio has almost never been lower and certainly not since WWII, implying extreme undervaluation, as seen in Chart 1.

Bill Gross on Stock Valuations

In his December Investment Outlook ("Dow 5000 Redux"), PIMCO's Bill Gross writes that regulatory and other responses to the current financial crisis will have a 'transgenerational' impact on stock market valuations:

My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner. Dow 5,000? We don’t have to go there if current domestic and global policies are focused on asset price support and eventual recapitalization of lending institutions. But 14,000 is a stretch as well. One only has to recognize that roughly 20% of bank capital is now owned by the U.S. government and that a near proportionate share of profits will flow in that direction as well. Better to own corporate bonds than corporate stocks, but that’s a story for another Investment Outlook.

The chart above, of historic P/E values, comes from Gross's Investment Outlook.

Friday, December 5, 2008

Shatner's Raw Nerve

William Shatner has new talk show on a cable channel I hadn't heard of before, Bio. Below are a couple of excerpts of Ginia Bellafante's review of it in this week's New York Times ("Captain’s Log: Celebrity Universe Probed for Signs of Offbeat Life").

The range of Mr. Shatner’s cultural contributions sometimes seems incalculable, and his tenure on “Star Trek,” is, of course, really just a fraction of his national gift. If YouTube offered nothing but his spoken-word renditions of classic rock songs (“Rocket Man,” “Lucy in the Sky With Diamonds”), it would still get thousands of hits, no millions and zillions of them. Google might have bought YouTube with no other content. In a 1978 appearance at a science-fiction awards show Mr. Shatner, seated, wearing a tuxedo and slowly fiddling with a cigarette as if it were a tiny baton, interpreted Elton John as if he were doing Beckett directed by Lee Strasberg.


“Shatner’s Raw Nerve” puts its host’s peculiar brand of intensity on full display. The set looks like the cavernous basement lounge in a Balinese hotel. Mr. Shatner sits in an armchair that butts up against his guest’s on a diagonal: he is so up close he looks as though he is going to spoon-feed whoever is seated there in front of him. I kept expecting the opening question to be, “So how about a spring roll?”

But Mr. Shatner is much more probing than that. What does he want to know? He wants to know what Valerie Bertinelli thinks about sin. This Lifetime television star is the first guest on the show, and what she has to say about sin isn’t going to put Thomas Aquinas out of business.

The photo above, of Shatner on the set of his new show with Kelsey Grammer (or Kelsey Grammer's arm, in this cropped version), is from the Times article. For those of you haven't seen the Shatner version of "Rocket Man" that Bellafante referred to, there it is below.

Thursday, December 4, 2008

Another Alloy Steel Post

In a post a couple of weeks ago ("Alloy Steel Update"), we quoted an e-mail from the CFO of Alloy Steel (OTC BB: AYSI.OB) in which he intimated that the company might file an 8-k or issue a press release about its fiscal fourth quarter results within the next week. At this point, since there's been no announcement from the company, it's likely we won't hear anything until Alloy Steel files its 10-k later this month. Alloy Steel's lack of emphasis on shareholder communication isn't new; the company still hasn't set up the investor relations section of its website. If you click on one of the tabs under the "Investors" heading on Alloy Steel's website, your taken to a generic page on the website of the company's outsourced IR web vendor (the stock image above is from that generic page.

In a discussion about Alloy Steel on its Investors Hub message board , I mentioned that I was less concerned about the previous quarter's results (which I think will be positive) than I was for the company's prospects in '09, given the global recession and the grim news from the mining industry. A commenter who goes by the handle "Littlefish1" explained why he was confident in the company's prospects during this downturn. Below is his explanation.

I have a lot of confidence in the company being around when things recover, excepting some kind of huge technological breakthrough in wear plates that puts all alloy wear plate into permanent obsolescence.

I don't have confidence in when they'll get around to putting out prelim or audited results though:) Except probably by the end of year. Hopefully much sooner but who knows. I don't want my eyes permanently crossed so am only going to cross them for one night.

If you look at the company's operating history, it is vanilla plain clear to see they know how to weather tough times. They survived years (especially 2001-2003 tough times) on practically nothing (IMO).

Unlike many micros out there, I would say the likelihood of them making it thru the next year readying themselves for a hopeful recovery at SOME point is extremely likely.

They've been thru this before with the Aussie miners. Plus now they have a little bit of chance to get themselves into new markets. They haven't borrowed from any banks. They have no dilutive instruments. They got thru 2001-2003 w/o diluting or borrowing from lenders.

And they have mostly paid for the 2nd mill already with internally generated cash. Worst case, knowing Gene's fiscal responsibility, they could just operate one mill until a 2nd is needed and adjust headcount to keep pace with what they have for work.

What is the WORST operating earnings loss they have reported in their operating history? One thing seems pretty clear with about 8 years of filing as a public company, they don't lose much money regardless of economic conditions and sales. And have tight cash flow management.

Plus without debt and with prior history of having opertaing income even on $500K revs Qs (I think even $400K Qs if I recall), I just don't think we'll see them evaporate. The cash they have IMO they will hold or spend judiciously. If they spend it, hopefully it is to finish off the 2nd mill and/or branch out to sales in US etc.

As ambu [another I-Hub commenter] mentions, they've probably missed out on some revs growth during this last commodity bonanza go-round by being so cautious. But it also means they should be fine in this downturn.

I think this company will be in a better position than before IF/WHEN we get a recovery (because of capacity upside, cash on hand for a change).

BUT when is that recovery? Who knows.

What would be a strong endorsement to the product quality and potential IMO is to see sales actually grow in this mining industry/commodity blowup. It won't be easy but one avenue to seeing that happen would be by tapping into markets they don't sell into much now (like the US).

As I mentioned in a previous post (Vaalco Energy Update), I sold a few shares of Vaalco to free up some cash to buy some more Alloy Steel. My limit buy orders for Alloy Steel haven't been filled yet though.

1"Littlefish" was the subject of a pair of posts here over the summer about his success with another micro cap stock, Mexco Energy: "How One Investor Found a Home Run Stock, Part I", and "... Part II".

Wednesday, December 3, 2008

PhotoChannel Update

Hat tip to reader N.L. for mentioning that are updates to the Q&A for PhotoChannel (OTC BB: PNWIF.OB) on the Value Investors Club site. Edelheit remains bullish on the Costco deal and estimates that PhotoChannel will end the year with $4 million in cash and no debt.

The image above is from PhotoChannel's Website.

Dealing with Deflation and Ameliorating a Recession, Part I

A number of columns have been written recently about dealing with the threat of deflation, including this one by Nouriel Roubini in today's Financial Times, "How to avoid the horrors of deflation". In that column, Roubini writes approvingly of the Fed's programs to purchase commercial paper, mortgage-backed paper and similar programs to increase liquidity and drive down borrowing costs for businesses and consumers.

With the bond market willing to lend the U.S. government funds at such low rates (e.g., 10-year Treasury yields at ~2.7%), why not take maximum advantage of that to stabilize asset prices and support aggregate demand? One fear is that, eventually, this orgy of borrowing will lead to a surge in inflation and interest rates when economic growth recovers, but it would seem that one way to ameliorate this would be to focus on buying assets rather than increasing outright spending.

For example, with many states facing budget shortfalls, instead of just giving money to the states, why not have the federal government buy a special class of 10-year municipal bonds from the states? The rate could be set at 50bps or 100bps over the U.S. government's current borrowing costs, which would still be a huge discount over the states' current borrowing costs in the municipal bond market. According to Bloomberg, yields on 10-year general obligation municipal bonds currently average 4.2%, so if these special municipal bonds sold to the federal government had a coupon rate 50bps higher than current 10-year Treasury yields (2.7%), they would still yield a full 100bps less than current 10-year municipal bond yields1. The proceeds from these special municipal bonds sold to the federal government would enable the states to make payroll, fund already-scheduled local infrastructure projects, and -- if the federal government purchased a large enough order of these bonds (say, an amount equal to double each state's current budget shortfall) -- to call some of their callable municipal bonds, thus lowering their overall interest expenses and taking further pressure off state budgets.

According to the the Center on Budget and Policy Priorities, estimated shortfalls in state budgets for fiscal '09 total about $80 billion, so it would cost the federal government about $160 billion to buy an amount of special municipal bonds equal to double the states' estimated '09 budget shortfalls. Since these bonds would represent assets for the U.S. government, and the U.S. government would recoup its investment (with interest) in ten years, that ought to temper concerns about this expenditure's long-term impact on inflation and interest rates and assuage the Treasury market.

1The coupon rates on the municipal bonds are of course what the states are actually paying in interest costs, but I'm using Bloomberg's yields as a proxy, for simplicity's sake.

Tuesday, December 2, 2008

"Too Many Bullish Arguments Suffer from a Lack of Imagination"

From Tony Jackson's column in yesterday's Financial Times, "Too many bullish arguments suffer from lack of imagination":

There seems to be growing support for the notion that equities have reached fair value. This raises two questions: how far it is true, and how far it is useful.

As to the latter, I described a month ago how the UK consultant Andrew Smithers, drawing on work by the US academic Robert Shiller, concluded the US market was fairly valued with the S & P 500 at 880 - roughly its level today. But as Mr Smithers also found, previous serious market collapses did not end until they were, on average, at only half fair value.

This is unsurprising. If markets never undershot, they would never overshoot either.

Later in his column, Jackson questions the conclusion of Morgan Stanley economist Joachim Fels's recent essay, "Neither Japan nor The Great Depression" (which was the subject of an eponymous post here last week):

Morgan Stanley has just produced a piece declaring that the present downturn is "neither the Great Depression or Japan". The argument boils down to saying that all previous policy mistakes have been avoided this time.

But that, of course, carries a hidden premise: that all possible mistakes were contained in those two episodes. That is, none of today's policy actions will turn out later to have been blunders.

Any takers on that one?

Vaalco Energy Update

Shares of Vaalco Energy (NYSE: EGY) are up about 33% over the last week, closing at $7.05 today, despite oil prices hitting a three-year low. I've got a limit order in to sell 5% of my Vaalco shares here to free up cash, which I may use to buy a few more shares of Alloy Steel International (OTC BB: AYSI.OB).