To boldy go where no fund has gone before…

The Big Game is in Africa

Christopher Columbus, Vasco da Gama, Captain James Tiberius Kirk. Those at the forefront of pioneering discovery have faced the gravest risks, but been covered with the most lustrous glory. It’s a lesson investors would do well to heed.

Of the many biases that cause amateur and professional investors alike to underperform the market or just lose their shirts, ‘home bias’ is one of the most insidious. It describes a syndrome whereby investors feel irrationally more comfortable investing where they’re familiar.

Enron employees invested their life savings in their company because it was what they knew. And as the FT reports, only 5% of Western pension fund assets are invested in emerging markets.

This is because we fear what we don’t understand, and ‘foreign’ countries are perceived to be more risky than they really are, to the world traveler and cross-border investor alike.

But the fortunes of the future will be made in what we used to call emerging markets, simply because that’s where the rapid growth is. The great Western economies’ best days are behind them. The UK and US are geriatric, limping, has-been economies, saddled by fiscal crises and hobbled by the law of large numbers: when you’re already so big, rapid growth is impossible.

Brazil, Russia, India, China, Nigeria. Welcome to the future.

How to make two billion in nine months

The Old Master's still got it

It must be downright embarrassing, if you’re a strapping trader in the prime of youth, MBA in hand, to be trounced by a 78 year-old man.

This is what precisely Warren Buffett has again done to Wall Street’s finest. Every time cynical pundits like Nassim Taleb argue that the old master investor is merely lucky, the hoary fox proves again that his market-beating returns have less to do with luck than balls of burnished brass.

“Be fearful when others are greedy, and greedy when others are fearful” is his simple mantra. This approach to investing gives the lie to the popular notion that the best investors are somehow ‘smarter’ than average.

Back in the heady, lunatic days of the dotcom bubble, Warren Buffett shunned the mad buying of stocks with no hope of generating profit. The word was, the old fuddy-duddy didn’t get this Internet thing. He’d lost his touch. We know how that ended.

They said the same thing when he struck a deal, at the depth of the financial crises, to purchase cheap warrants for Goldman Sachs’ undervalued stock. Others could have made the same bet, but amid the panic, following the herd felt safer.

Pundits like this chap speculated that Buffett had lost his touch, as Goldman’s share price fell further after the deal. They’re not saying that now. After record profits announced last week, Buffett has pocketed a cool $2 billion or 44% return on the warrants- excluding the guaranteed 10% preferred dividend. Fortune, indeed, favours the bold.

Earnings Season: Winners and Losers

The Korean Won: LG kicks Nokia's whatsit

Here at Amusis, we make business a spectator sport. We particularly enjoy front row seats during Earnings Season.

This quarter is particularly riveting, due to the sheer volume of red ink on display. All sports fans know that the most satisfying moments involve disaster: the ski jump that send the skier sprawling head-first into a snow bank; the cage fight knockout that results in a particularly gruesome blood spatter.

There is similar joy in witnessing monumental business losses. Former banking titan Morgan Stanley floods Wall Street with blood (or is that red ink?) for the third straight quarter. By contrast, high-scorer Goldman Sachs struts victoriously across the field, throwing bailout money back in the government’s face.

But not only business behemoths suffer disaster. Here in the UK, 52 pubs are closing every week, suggesting the unbelievable possibility that Britons are actually drinking less. But the balance of news was favorable today, as most corporations defended margins against falling revenues by laying-off staff.

Boeing for example, reported profits up by 17%, and Wells Fargo showed that not all banks are in the business of losing money. But the most delightful smack-downs were in Technology, where Apple demonstrated why high margin products targeted at price-insensitive buyers is a winning formula.

LG similarly demonstrated the power of branding. Its sexy smart-phones with names like Prada, Chocolate and Cookie took a big bite out of Nokia’s boring lineup of grandma phones. Who said business was dull?

Profit or Loss? The Earnings Nailbiter

Oh, no- It's a negative earnings surprise!

It’s that season again: people are imbued with a lustrous lightness of being, and with the dark days of winter behind, are looking forward to green shoots and flowering signs of earthly renewal.

No, we don’t mean spring and summer: we’re talking about earnings season. With the books for Q2 closed, a tidal wave of earnings releases is surging as we speak and will deluge us soon enough.

This season is particularly fraught with significance, because to the nail-biting nervous wrecks on Wall Street and in the City, it is the litmus test of the economy’s true health and prospects.

Over the past few weeks, global stock markets have exhibited a pronounced whiplash action, as sentiment veered sharply between bladder-loosening panic and sphincter-tightening greed. General Electric lost 47% of its profits, but glorious Goldman Sachs reinforced their position as the world’s most splendid capitalists.

With many more results to come, the markets have chosen to celebrate early. And not content with declaring obscene profits, Goldman Sachs is stoking the exuberant mood by predicting a 15% rise in the market by year end.

How soon we forget. Yes, the index of leading indicators may be pointing up slightly, and even gloomy Cassandras like Nouriel Roubini are saying the recession might end this year. But in the small print of his remarks was the fact that governments will have to raise both interest rates and taxes, to cover their monumental deficits. Happy days are not quite here again.

Bernie Madoff with the Cash

So alike, so different: who would you trust?

Bernie Madoff never stood a chance of a lenient sentence. It would be a courageous jurist who let him off lightly.

Today, the crooked financier bagged a majestic 150-year jail term. The enormity of the sentence was a befitting tribute to the largest Ponzi scheme in history. Rich people, charities, widows, orphans and investment professionals- all were his victims, and many were in court, rending their hair and clothes and baying for blood.

They got it. But we suspect much of their rage was misdirected anger at their own gullibility and carelessness. As investment professionals ourselves, its hard to pity people who lose their nest eggs by putting them all in one basket.

The neuroscience of greed that Madoff exploited is the same one that causes people to lose their life savings speculating in bubbles. Stock prices that can only go up; real estate prices that cannot go down; oil prices spiking to the sky; investments that ‘guarantee’ a steady, lucrative return: all these fire the greed centres in our brain.

We then jump the bandwagon, unwilling to be left off the gravy train. A tentative foot in the water is handsomely rewarded, and then we sell our homes and hock our jewelry to raise the cash to speculate even more, in the logical fallacy that yesterday’s returns must be the same as tomorrow’s.

There will be more Madoffs and more bubbles. To avoid being a victim, remember only one old aphorism: if it sounds too good to be true, it probably is.

The Price is Wrong!

Your demand curve is unpatriotic, Komrad

Prices are the lubricant of the economic engine. They are the sauce and the sweetener of commerce. The price we pay directly influences our personal calculus of the value we receive.

This is why, when times are tough, the temptation to meddle in prices is simply too strong for populist politicians to resist. The entire communist system was predicated on the idea that Komrad Daddy knows best what the price should be. We all know how that played out.

However, in tough times, we tend to revert to type. This might explain President Putin’s farcical foray into price control at the retail level. The lesson for all aspiring politicians: when things go wrong economically, always blame the businessmen. When they go well, naturally you should take the credit. Works every time.

But ham-handed attempts to force the market to behave are not restricted to Kremlin-trained strongmen. The Chinese authorities too are harassing Google for facilitating the demand for pornography amongst the country’s morally upstanding youth. Sometimes, as with the drug wars, it’s just easier to go after the suppliers than acknowledge the uncomfortable fact that without demand, they wouldn’t be in business.

The UK’s FSA is also planning to enter the price-control business. Financial advisers- who are really just a misnomered retail channel for investment products- will not be able to earn sales commissions anymore. The idea is that they should recommend what is best for the customer, rather than what pays the highest commission.

However, this rule ignores the fact that financial advice is a very different business from retail selling. Incentives are needed at retail. The result will just be lost revenue ($799 million) to these retailers, and a switch of wholesaler marketing funds to pull strategies that target the consumer directly.

In economic news, the funny phrase ‘less than expected’ is again being used to describe the US economy’s contraction. This reflects a desperate desire to see the economic glass as half-full, reflected in analyst’s hope that Q2 earnings season will be more profitable than Q1.

We just can’t see how this will happen. Aggregate unemployment in Q2 was higher than in Q1, and output lower. Unemployed people with negative home equity don’t spend very much. We await Q2 earnings season with keen interest.

Search Me, or The Cycle of Hype

In the Internet age, no new technology succeeds without a healthy boost of celebratory hype. And no new technology launch generates more hope and hoopla than those of search engines designed to dethrone almighty Google.

Many search engines have launched and died ignominious deaths, flickering brightly on the hype radar only to crash and burn in the face of Google’s invincibility. Microsoft’s Live Search, AltaVista, Ask.com, Mahalo, Cuil, Dogpile– all ended up on the….well, dogpile of history, while mighty Google thrived unencumbered.

The latest aspirant to tilt at Google’s windmill is much-hyped ‘computational knowledge engine’ WolframAlpha. Now, first of all, WolframAlpha is a pretty cool name, no doubt about that. Much better than say, Mahalo. However, ‘computational knowledge engine’ sounds suspiciously like the kind of hot air on which successful corporate careers are built. We put it to the test.

The results were middling. First, Wolfram Alpha doesn’t know what double-entry bookkeeping is. Secondly, the only thing it knows about grammy-winning musician Alicia Keys is her birth date and age. I’m sure this thing is very good at something (we hear it is magnificent at computing problems appertaining to fluid dynamics). But since most of the human race can neither understand nor does care about fluid dynamics, we conclude that Google’s dominance is safe for now. Perhaps WolframBeta might have better luck.

Elsewhere, oil prices have continued their steady climb, meaning that Q2 average prices are solidly above those of Q1. Which makes it a mathematical certainty that oil producers’ revenues will ‘suprise’ on the upside come the next earnings season. It’s a classic case of the markets under-reacting to significant but mundane news and mispricing stocks on the downside. If you haven’t bought Big Oil shares yet, now is the time. This one for example is selling at single-digit P/Es, as is this one.

The second one, a name you might know well, is suffering some temporary embarrassment over executive pay, which probably makes the stock even more of a bargain at this point. It does make one wonder, though: what’s the point of becoming a senior executive of a gargantuan corporation if one cannot line one’s pockets when one gets there?

In economic news, China and Brazil respond to the dollar’s falling like a ton of BRICs by mooting the idea of “an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run.” In other words, a global currency. One currency to rule them all, remove conversion transaction costs, and eliminate currency risk forever. A noble goal.

In Korea, the spectacle of ghosts airports (or as we like to think of them, ‘runways to nowhere’) with more staff than passengers indicates what happens when you let politicians get their hands on funds that should be allocated by the market. They tend to find something to subsidise with it, with predictably messy results. And lastly, our theory that enhanced romantic activity is the normal human response to economic gloom has been borne out by the spectacular financial results of the parent company of Durex.

The Good News, or the Bad News?

These distressed assets sure are tasty, Jim.

It’s trite, but true: every cloud has a silver lining. And in the midst of recessions such as these, vultures do well.

Such seekers of carrion as buyout funds, distressed debt investors and contrarian stock-pickers will strike luscious bargains to their selfish benefit. However, they also fulfil the market’s essential capital reallocation function, much as vultures in the wild recycle the rotting carcasses of the dead.

Which raises the interesting question: GM stock, buy or sell? Is this fallen behemoth the ultimate turnaround stock play, or a black hole of investment death? Well, when insiders and top executives disclose that they’ve sold their own shares, it’s time to abandon ship. With $91 trillion in negative equity, and a stock trading at under $2, it’s not hard to see why. RIP, GM. It was fun while it lasted.

In other double-edged news, US house prices have dropped by their greatest quarterly percentage ever. The reason of course, is those vultures. Banks are stuffing the market with foreclosed homes, driving down prices, and carrion investors are snapping them up vocariously. For those losing their homes, tough cheese. For those buying homes at bargain prices, not so tough.

Then again, as Time magazine correctly points out, many of the people losing their homes are simply reaping the harvest of their own greed and irresponsibility, much as those struggling with credit card debt are suffering the wrath of their own self-indulgence.

Society for some perverse reason, holds everybody accountable except the individuals who overstreched themselves in their own blind hunger for instant gratification. Not us. If you bought too much house, or got too deep into credit card debt, here’s our message to you: serves you right. Suck it up. Now someone please tell the FSA Chairman to get the hell out of the way, before his pointless new regulations capping mortgages create perversions in capital allocation. The problem with regulators, we always say, is they feel the need to regulate something before lunch.

A somewheat more sensible bureaucrat has resisted union pressure to raise the UK’s minimum wage above the rate of inflation. Now, those graduating generation Y noobies can discover the character-building joys joys of burger-flipping.

And the last double edged sword: UK unemployment has surged by 224k in Q1. For some reason, this is considered good enough news to cause a rally in the pound versus the dollar. Or perhaps it was the dollar that fell against the pound, as the US trade deficit widened further, like the maw of some insatiable titan stretching to consume the prosperity of Americans yet unborn.

I trust you took our advice to buy Big Oil? Because if you didn’t, with oil prices rising like this, you will wish you did come Q2 earnings season.

Stress tests and black babies

Is that stock option for me?!

What does the typical black CEO look like?

Perhaps thanks to President Barack Obama’s election, academics are being emboldened to ask questions on race in the enterprise that were previously considered hot potatoes. The journal of Psychological Science is reporting that the typical black CEO is a baby-faced, mild-mannered smooth talker whose overall demeanour can be best described as ‘unthreatening.’

The presumption is that black men who bang the table or act in any way threatening to the white establishment will be consigned to processing invoices in the back office for the balance of their careers. So if you’re a smart, ambitious black man, please cut those dreadlocks, develop an agreeably timid manner, perhaps bleach your skin a little, shrink your nose and increase the size of your eyes and forehead. Don’t say we didn’t warn you.

In the markets, McDonald’s displays decidedly contra-recessionary results, increasing sales 6.9% by re-engineering their product mix to include more comfort food. When your home is being repossessed, there’s nothing like succulent chicken to make the pain go away.

Elsewhere, as we reported yesterday, the government’s much vaunted stress test results show that the panic over the state of the banks was overdone. Some need capital injection, many are just fine. Those that aren’t have died off, and that’s perfectly fine. It’s the Darwinian logic of the market. And the market signals its approbation by swelling approvingly. This is beginning to feel uncomfortably like a new bubble.

Simultaneously, oil prices continue a slow, steady climb, meaning average prices this quarter are already higher than they were in the previous one. So if you’re not currently buying oil stocks, you need a stress test of your own.

You should probably also buy Toyota. Despite its historically disastrous results, if the market overreacts enough on the downside, it just might be the ultimate cyclical play. If one auto company will survive this recession, it will probably be they. And maybe Tata of course, as they’re once again demonstrating a consistent genius for making money at the bottom of the pyramid.

We must end today with outrage. If there was one institution more culpable than most for the current financial crisis, it is gargantuan Government-controlled entity, Fannie Mae. This market-distorting behemoth was responsible directly or indirectly for the bulk of US sub-prime mortgages. Now, after receiving $15bn in bailout money, this money-destroying Leviathan is back to beg for more. Is there nothing that can kill this monster?

The Humbling of the Gods

Icarus: Blowing up in style

2008 was the year that destroyed the myth of the omniscient investment manager.

Wall Street and the City of London ran red with the blood of hedge funds, asset managers and investors of every stripe. No asset class was spared, no geography was immune from the ravages of the sub-prime Armageddon. Debt, greed, loose money and financial alchemy combined in a cocktail of combustive potency that once ignited, embroiled us all in a furious, final conflagration.

Now, earnings season is revealing the impact on some of asset management’s brightest luminaries. Legg  Mason’s Bill Miller blew up spectacularly after 13 straight years of beating the market. Its shares fell an excruciating 22% after it reported its fifth straight quarterly loss. Nassim Nicholas Taleb must be gloating. UK asset management powerhouse Aberdeen Asset management was similarly humbled, after its profits fell a traumatic 45%.

Surely Warren Buffet, doyen of capital allocators, fared better? Alas not. The 78 year-old Sage of Omaha faced his most uncomfortable AGM ever, following his worst investment year in history, as shareholders grilled him on his succession plans, and second-guessed a number of his investment choices (presumably believing they could have done better, I imagine).

The unaccustomed humiliation of Buffet notwithstanding, he and fellow hoary compatriot Charlie Munger still dropped pearls of investment wisdom for those willing to heed. Successful investment, they cautioned, is not reserved for the brainy, and the complex mathematical and quantitative models that investment managers use to bamboozle the unitiated, are mere smokescreens for their own inadequacy. Simply put, finance people make simple things seem complex to make themselves look smart.

The decimation of the ranks of the hedge fund universe has not stopped clueless regulators, behind the curve as usual, from proposing the usual raft of knee-jerk regulation. Gentlemen, calling for more hedge fund regulation is soooo Q1. Please move on, will you? There’s nothing to worry about.

After all, Libor is falling (to below 1%), Fed Chairman Ben Bernanke is testifying confidently that a recovery is imminent, the Bank of England is actually pumping less loot into the system as bankers loosen their spurse strings, and a mini-stock market bubble is even forming. Just like the good old days.