Monthly Archives: July 2011

is News Corp a buy?

July 14, 2011 By in Industry Analysis, Publishing, Stock ideas, Trading Tags: , , , , , , Leave a comment

Is News Corp a buy?

The short answer is that I don’t know. But I do think that analysts recommending the stock on t idea that it’s unduly depressed by the current scandal in the UK are premature. I have two observations:

By far the most valuable asset in the News Corp empire is Fox media in the US. Your first question should be whether you really want to own it, even at today’s lower price

I also think that Americans will tend to underestimate how serious the political situation for News Corp in the UK might be.

I think Americans are most influenced by the letter of the law. We have a quiet admiration for a scoundrel who can wriggle out of the onerous terms of a business deal by finding an obscure loophole in the legal documents that govern it. And we approve of an astute lawyer who can win his case on a technicality.

In my experience, the UK is different. There, the spirit of the law is more important than the letter. The intentions of the lawmaker—which it is assumed everyone understands—are sacrosanct. In the cellphone and email hacking case, it seems to me the accepted response is not a sharp legal defense, but rather admission of guilt on all charges, immediate corrective action, and an apology and plea for clemency. Anything short of that—and I don’t perceive this as being News Corp’s response to date—will likely result in severe legal penalties of a type that Americans would never expect.

One must also ask whether what happens in the UK with News Corp will have negative fallout in the US. I don’t expect it, but I don’t see there’s any rush to buy News Corp stock, either.

Boston Consulting Group: traditional money management industry in long-term decline

July 13, 2011 By in Constructing a Portfolio, Getting financial advice, Industry Analysis, internet, Investment firms, Portfolio management Tags: , , , , , , Leave a comment

the BCG report

The Boston Consulting Group just released its ninth in a series of analyses of the global asset management industry.  This year’s is called Building on Success: Global Asset Management 2011.

BCG’s conclusion:  the industry is in long-term decline, despite a bounceback in profitability during 2010 caused by rising markets and an investor shift out of low-fee money market funds into more expensive products.

Reasons:

–the industry is mature everywhere except in emerging markets, so growth isn’t going to come from finding new customers.

–existing products aren’t good enough, with active managers typically offering one-size-fits-all products that don’t beat their benchmarks.

–competition is intensifying.  It takes two forms–price competition among industry participants; and the development of competing offerings, like hedge funds or private equity, that siphon assets under management away from the industry.

–there’s a steady flow of money away from high-fee active and equity products  and toward  lower-fee passive and fixed-income ones.

–in both the US and Europe, a small number of firms have established extremely large relative market shares.  This gives them economy of scale advantages that let them lower prices and still maintain their own income.  In US equities, for example, 5% of the funds took in 53% of the new money in 2010.  The bottom 50% of the market took in only 4%.  The European equity business is even more concentrated than that, as is the US fixed income sector.  In European fixed income, where concentration is somewhat less, the top 5% took “only” 38% of the new money.

my thoughts

I agree with BCG that we’re seeing a sea change in the asset management business.  I’d put the situation slightly differently, though.

Before Black Monday in 1987, investors tended to buy individual stocks rather than packaged products and to rely for advice on savvy registered reps employed by traditional (read: high cost) brokerage houses.  The market crash changed all that.  The antiquated NYSE system of having monopoly market makers (good for their profits, not ours) froze up; volume disappeared and bid-asked spreads became very wide.  Put in a market order and your execution could differ by 5% from the last price you saw on a screen.  And it seemed that the 5% was always in an unfavorable direction.

This experience, and the sense that the world was getting to be too complex for non-specialists to decipher, sparked a change in investor preference away from individual stockpicking toward buying professionally-run mutual funds.  At the same time, 401ks were becoming more in vogue.  Brokerage houses decided to limit their legal liability by turning their reps into marketers of computer-generated financial planning advice and mutual funds. The Baby Boom was just coming into its peak earning years.

I think the Great Recession and the accompanying sharp decline in world stock markets have triggered another sea change.  This time it’s a return to do-it-yourself for individuals, based on the assessment (right in most cases, In think, but wrong in some) that brokers are professional marketers, not trained investors, and add little value.  In any event, their firms limit what they can say and do.

The Baby Boom is starting to enter retirement.  Investment results are more critical than they were before; losses are more painful.  So boomers are dialing down their risk profiles by selecting passive products–through ETFs–and fixed income.  On top of this, on retirement Boomers are becoming their own Chief Investment Officers as they take charge of managing their 401ks or other defined contribution pension plans.

For institutions, which have long known that their favorite active managers underperform, it’s a switch to “alternative investments,” despite evidence that for the past decade managers of the latter have performed worse than traditional active managers.

For both classes of investors, it seems to me the change has the character of rejecting the devil you do know, figuring the one you don’t can’t be that much worse.

 

There are obvious issues with this change, assuming I’m correct.  Personally, I think pension sponsors are crazy to be building up their allocation to alternative investments.  The risks are high, the reported numbers aren’t that great, and there’s lots of anecdotal evidence that some of the reported numbers don’t stand up under more than cursory scrutiny.

For individuals, which is my main focus in writing this blog, the issues are somewhat different.  They’re how to get the information you need to make intelligent decisions, and who do you trust. Personally, I think that the investment management industry will follow the same pattern as traditional bricks-and-mortar retailing.  It, too, will morph (is morphing) into diffuse internet-connected collections of professional investors working in small groups and selling research or advice at reasonable prices.

 

 

 

states casting about for new revenue sources

July 12, 2011 By in economics, Industry Analysis, internet Tags: , , , , , , Leave a comment

States in the US are trying to repair tattered balance sheets.  In addition to laying off workers and trying to reduce compensation to remaining employees, they are also working hard to develop new revenue sources.  Here are two of the most recent developments:

1. California just passed a law taxing sales over the internet.  It applies to purchases made by California residents from online companies that have a presence in the state.  You’d think that “presence” means factories, warehouses, sales offices, or bricks-and-mortar retail outlets–and it does.  But the new law also says that if a shopping comparison or coupon site located in California refers a customer to an online retailer, and the customer buys something, the fact that the comparison site is in California counts as a presence of the online retailer in the state.

According to the Los Angeles Times, Sacramento figured this new wrinkle to the sales tax would raise $317 million a year in new revenue.  What could they have been thinking?

What’s happened instead is that online retailers from Amazon and Blue Nile to Overstock and Zappos (yes, it’s cheating.  Zappos is part of Amazon, but I needed another end-of-the-alphabet site) have severed relations with the 25,000 or so comparison sites (oh, those wildly entrepreneurial Californians!) the Golden Sate has spawned.  Amazon has apparently sent its (former) affiliates a letter advising them to move out of state if they want to reestablish themselves with the online superstore.

According to the Financial Times, some couponing sites have lost up to 30% of their business since the new law went into effect.  More specialized sites appear to have seen the majority of their revenues evaporate.

Let’s assume that the 25,000 referral sites average four employees each (I’m making these number up, just to try to get a sense of the impact of the new tax).  That’s 100,000 jobs.  If half of the industry either relocates to other states or goes out of business, the new tax will have quickly generated a loss of 50,000 positions.  If each worker had been paying $5,000 yearly to California in sales, income property and other taxes, then the legislation would cause an annual loss of $250 million in state and local revenue.  And that’s without calculating unemployment benefits for laid-off workers.

…not exactly what the doctor ordered.

By the way, Amazon is urging a referendum on the tax, according to the FT.

2.  New York is redefining–“clarifying” might be the word the state would use–what it means to be a resident of the state for income tax purposes.  Details of two recent court cases that bear on this issue, the Barkers and John Gaied, can be found at taxdood.com.

Resident vs. non-resident–what’s the tax difference?  Non-residents pay income tax on income earned in New York;  residents pay income tax on all their income, including investment income.

The Barkers live in Connecticut, Mr. Gaied in New Jersey.  That’s where they vote, where they have their driver licenses, where their cars are registered, where they serve on juries, where their mail gets delivered (Mr. Gaied has some delivered to Staten Island, as well), where their kids go to school.

But,

1.  Mr. Barker works in Manhattan as an investment manager ; Mr. Gaied operates a gas station on Staten Island. Because of their work, both spend more than 183 days a year in New York State.

2. The Barkers own a vacation home on Long Island that Mrs. Barker’s parents use and they visit rarely;  Mr. Gaied owns a house on Staten Island that he bought for his parents to live in.

That’s enough to make them both residents of New York for tax purposes.  The facts that neither party spends much time at their New York houses, and that their primary residences are elsewhere, make no difference.  Owning and maintaining a residential property in New York State that looks like it could be lived in year-round is the essential thing.

Of course, the Barkers are also residents of Connecticut for tax purposes–so they’re taxed twice;  Mr. Gaied is similarly a resident of New Jersey.

According to the tax authorities, the Barkers owe an extra $608,000 in taxes to NYS for the years 2002-04.  After penalties and interest, the total bill is $1.055 million (an aside:  the tax bill implies the Barkers had over $6 million in investment income during the three years.  Wow!).

In the Gaied case, taxdood.com says the courts initially ruled in favor of Mr. Gaied, but political armtwisting got the matter reheard.  In round two, Mr. Gaied lost.

I think this effort by New York State bears watching.  My guess is that NYS is starting small, and will be aiming for bigger fish as the file of precedents gets bigger.  The tax authorities may end up raking in a pile of money.

It would be interesting to know what percentage of house/apartment owners in the Hamptons, or the Adirondacks, or the Catskills or the five boroughs of NYC are out-of-staters.  If it’s over 10%, these tax rulings can’t be good either for the construction industry in these areas, or for property values.

It seems to me that anyone who might be affected should either turn the property into rental real estate–so the property can’t be construed as a residence–or sell, in order to stop from running up additional tax liabilities.  And the news is certain to make vacation home seekers think more fondly of the Jersey shore or eastern Pennsylvania.

Stay tuned.


 

the influence of speculators in the crude oil market

July 11, 2011 By in Current Market Thoughts, Energy, Industry Analysis, Stock ideas, Strategy Tags: , , , , , , , , , , , , Leave a comment

The conventional view taught in business schools is that speculation is good.

Boiled down to its essentials, the argument supporting this view is a very simple one:  suppose there were no one to take the other side of the trade of, say, a farmer seeking to guarantee a minimum price for his corn crop that would ensure he’d cover his costs and have something left over to keep body and soul together.  There may not be enough cereal makers or animal feed producers who want to hedge their costs in the same amounts and at the same time as the farmer.  If not, who’s left to be the buyer of the commodity contracts the farmer wants to sell?  The answer:  speculators, who have purely financial motives and who will step in to stabilize a market by buying and selling commodity futures contracts before prices get too wacky.

In this picture, the main players are the producers and users of commodities; speculators play a minor role, though a convenient one for the theory.

 

I don’t know whether this was a solid description of the way commodities markets worked a generation or two ago,  or just a product of the many simplifications of the real world that academics need in order to have their mathematical models work more smoothly.  But even if they once were correct, do these ideas still work in a world where prop trading, hedge funds and commodity-based ETFs abound, and where brokers have made it much easier for ordinary investors to buy commodities futures directly?

the case of crude oil

In 2008, after an oil price spike that saw the price of crude nearly double from a starting point of $80, the Commodity Futures Trading Commission issued a report, based on the traditional thinking, which found that speculation played little role in the upward move.  The Baker Institute of Rice University is the most well-known of observers who criticized the CTFC findings.  It said the commission had ignored its own data, which showed a dramatic rise in the involvement of the proprietary trading desks of investment banks, of hedge funds, and of commodity funds in oil trading.  On the Baker Institute’s reckoning, these speculative entities made up half of the market (and they all wanted to bet that oil price would rise).

Apparently in response to this criticism, on July 5th,the CFTC published a relatively large set of data showing the relative importance of hedgers and speculators in various commodities markets, including crude oil.  What called my attention to the report was an article in the Financial Times that says speculators make up a majority of the trading in metals, agricultural and financial futures–but in crude oil, they comprise well over 90% of the trading volume!!  (I’ve cast my (unpracticed) eye over the figures.  I don’t see the 94.5% speculation the FT reports, but most categories of crude show hedgers make up less than 20% of the market.  Same difference.)

my thoughts

The CFTC is proposing that the government limit the number of positions a speculator can hold as a way of limiting their influence.  And the International Energy Agency has already organized a limited release of some of the crude oil stocks held by oil-consuming nations in an effort to cause speculators to liquidate.

CTFC action would just make speculators relocate, however.  The IEA has a worry, too –that speculators have deeper pockets than it does.  Both agencies are treating symptoms, not the root cause, of high oil prices.

In a lot of ways, the current oil situation reminds me of froeign exchange during the Bretton Woods era of fixed currency rates.  During Bretton Woods, countries periodically tried to defend a certain currency level, even though that level was ultimately being undermined by structural economic problems that at least one of the countries involved refused to address.  The banks speculating against the currency exchange rate were, in effect, betting that the structurally weak country didn’t have the political will to make needed changes.  Generally speaking, the banks were right.  They thought it was like shooting fish in a barrel.  Ultimately, the Bretton Woods arrangement collapsed.

The structural issue for petroleum in today’s world is the failure of Washington for more than a third of a century to fashion an effective energy policy that reduces the country’s dependence on crude oil.  In part, this has been a way of protecting a politically powerful but badly run domestic car industry–which is even now lobbying hard against proposed increases in fuel efficiency standards for cars and trucks that would bring the US into line with the rest of the developed world in ten years or so.

The massive speculative bet is that the current situation won’t change much–resulting in higher oil, a lower US dollar and slower economic growth in the US than would otherwise be the case.

investment implications

The straightforward bet on this issue would be for or against the stocks of oil producing companies.  Slow growth domestically and a weaker US$ would also favor US-listed companies with significant operations outside the US, however.  For anyone, like me, in the weak-$, slow-growth US camp, I think the latter group of stocks will do relatively well under most oil price scenarios, making them the better way to go.

 

 

the June 2011 Employment Situation report

July 10, 2011 By in economics, employment, Employment Situation report, Portfolio management, Recent Market Action, Strategy, Technical Analysis, Trading Tags: , , , , , , , , , , Leave a comment

The Bureau of Labor Statistics released its June 2011 Employment Situation report just before the start of New York trading on Friday.  In essence, the data confirm the message from the May report that job creation in the US has slowed dramatically from the 200,000+ per month clip of February-April.

the data

The June report indicates that the domestic economy created 18,000 new jobs during the month.  The private sector chipped in 57,000 positions, 53,000 of them in services and the remaining 4,000 in goods production.  Governments laid off a net 39,000 workers.

Also, April and May figures were revised down.    For May, reported private sector hiring dropped from the original +83,000 to +73,000; government layoffs increased from 29,000 to 48,000.  April private sector gains fell by 10,000 to +241,000; government layoffs increased by 5,000 to 24,000.

The May and June Employmnet Situation reports are similar in three respects:

–hiring in goods-producing industries has dropped from a 40,000 monthly pace earlier in the year to just above zero;

–service industries, which had been adding over 200,000 new workers a month, have dropped to under a third of that, and

–government layoffs have accelerated by 10,000-15,000 jobs a month.

why the slowdown?

No one really knows.  It’s possible that part of the jobs falloff is due to supply-chain disruptions caused by the devastation in Fukushima in March.  But that would account for at the very most for a third of the decline.  It’s also possible that employers are worried about the parlous state of politics at home or in the EU.  Or the current state of affairs may simply be the standard pattern of recovery after a devastating financial crisis.

As I observed a month ago, the Employment Situation numbers conflict with more positive employment data from private sources.  Since then, we’ve seen June retail sales figures, which were surprisingly strong. And in its admittedly highly volatile employment report, payroll company ADP said a few days ago that it thinks the US economy added 157,000 jobs in June–most of the gain due to a surge in service sector hiring.

the stock market meaning?

There was a lot of hand wringing by TV commentators on Friday morning about the BLS announcement.  The lack of job growth in the US also made the Saturday front page of all the newspapers I read.  This is partly because bad news sells, partly because the bullish EDP report fooled many economic “experts” into substantially raising their BLS estimates at the last minute, leaving them with egg on their faces.  True to their usual form, although the BLS report was a disappointment, pundits made it seem that the whole problem was the economy and not their estimates.

To my mind, Wall Street trading tells a somewhat different story than the media.  Specifically,

–on Thursday, the S&P reacted to the positive ADP report by gaining 1%.  On Friday, the market rallied from session lows just after 11:00 am to close down .7% on the day.  In other words, for the two days the New York market was up.  That wasn’t the very negative result one might have expected, based either on the poor BLS report or the palpable anguish of talking heads.

–I hold ten US stocks in the actively-managed portion of my taxable stock portfolio.  Four of them were up on Friday, and by enough to put the collection of ten in the positive column for the day.  Admittedly, one of my main objectives over the past couple of years has been to find US-listed companies with substantial exposure outside the US.  Still, it seems to me that the selloff on Friday was much less across-the-board than the one that greeted the May BLS report.

–add to this the fact that the rally came on a Friday afternoon, when (very) short-term traders are deciding whether to hold positions over the weekend.  A late afternoon selloff–not a rally–would have been the more natural outcome if traders were feeling bearish.

We’ll see more when trading resumes on Monday.  But so far it seems to me Wall Street has shrugged off the BLS news to a greater extent than I would have expected.  It may be that Wall Street is beginning to make two distinctions I think are important to understanding the profit potential of US-listed stocks.  They are:

–the difference between the structural social/political/ethical problem of having an extra 5% of the workforce unemployed for an extended period of time, and the stock market issue of the spending behavior of the 90%+ of a (growing) workforce that is beginning to get compensation increases for the first time in a few years; and

–the difference between a domestic bond market whose performance is dependent on the strength or weakness of the US economy, and a stock market, half of whose earnings come from outside the US and whose domestic half has virtually no exposure to housing, real estate, construction or autos.  (By the way, this stock market structure is the norm for every other major equity market in the world.)