Counting Swans on Wall Street
American tourists in London have become objects of pity. The poor people – they’ve come all the way over here, say the locals, and now they don’t have the money to enjoy themselves. Monday, the dollar touched a 26-year low against the English currency. The dollar has dropped well below 2-to-the-pound. Tourists go about in a state of shock and awe. When they buy a hamburger they find that it costs as much as a rib-eye steak at home. They hop in a taxi and wish they had refinanced their home before making the trip. At the Savoy or Claridge’s, before giving customers their bills, bellhops are positioned directly behind them, to catch their wallets as they fall.
America’s markets were closed yesterday for the 4th of July celebrations. But America’s money was marked to market all over the planet. Wherever it showed up, it was greeted warmly – but not quite as warmly as a month ago.
While dropping below the 2-to-the-pound level in London, on the continent, the greenback lost ground too. At $1.36 to the euro, it is near its all-time low.
The dollar seems to have the weight of the entire world financial system on its shoulders. And what a system it is!
We are amazed. We are flabbergasted. We don’t see how it can continue.
And yet, as a dear reader, tells us below…we’ve been saying that for a while…and the Great Reckoning may not come for another 40 or 50 years!
But there is a day of reckoning in financial markets every day, too.
Take the boom in deals, one of the most remarkable features of this market. We have never seen so many deals…or such rich ones. On Tuesday, KKR announced that it would try to get $1.25 billion out of the public’s pockets. Och-Ziff Capital Management, a hedge fund group, earlier said it was looking for $2 billion.
Meanwhile, the Carlyle Group is taking Manor Care private for $6.3 billion and Hilton Hotels is being bought by Blackstone for $20 billion. And the biggest private equity takeover ever is underway in Canada, where Bell Canada Enterprises is going for $32.6 billion in cash, plus $15.9 billion in debt.
The hedge funds and private equity firms are not only doing deals…they’re BECOMING deals themselves. “Hedge funds continue public path,” says the NY TIMES. They’re moving into the public markets for a simple reason – there’s money to be had there. But what kind of system is it where the public investor thinks he can profit from funds that make their money by outsmarting him? ‘Never give a sucker an even break’ is like the Lord’s Prayer at KKR, Blackstone and Och-Ziff. They repeat it in unison at board meetings. They put it on their business cards. They have it printed on their securities and I.O.Us.
Of course, when these companies file to go public they are forced to open their doors so we can see what they’ve been up to. In the case of Och-Ziff, we find that their performance for several years has been about the same as the S&P. Why would an investor pay ‘2 and 20’ (2% of capital and 20% of performance is standard hedge fund pricing) to get the same thing he could get by throwing darts at the S&P listings? Because it is less “risky.” Och-Ziff got the same numbers as the S&P but with substantially less volatility.
Wall Street cannot really measure risk. It doesn’t know any better than we do when the “black swan” is going to appear. Our friend Nicholas Taleb has made the black swan famous – pointing out that just because every swan you’ve ever seen has been white, it doesn’t mean the next one won’t be black. Wall Street looks back and counts swans. If it counts 20 white ones and 1 black one, it puts the ‘risk’ of a black swan appearing at 5%.
Counting the swans in the S&P performance and comparing them to Och-Ziff’s record may or may not be meaningful. Maybe it is worth paying a premium to get the whiz-kids’ lower-volatility performance. But our guess is that when a real black swan comes along both the S&P will go down…and Och-Ziff along with it.
By the by, you can catch Nicholas Taleb (along with all of your favorite DR editors) at this year’s Agora Financial Investment Symposium, which takes place in Vancouver on July 24-27. If you haven’t gotten your ticket yet, there is still a way to attend the Symposium – for free.
The Daily Reckoning
Thursday, July 5, 2007
Addison Wiggin, reporting from Baltimore…
“With empathy, major global currencies retracted some of the gains against the nation’s beleaguered currency over the holiday. Slightly. The euro slipped seven hundredths of a cent off its all-time high. The pound sterling and the Aussie dollar also backed off roughly 20-year highs. Interest rate decisions from both the European central bank and the Bank of England will be made public today… watch this space for comment.”
For more from Addison, see today’s issue of The 5 Min. Forecast
And more views:
***Meanwhile, we learn of another item in the inventory of American dependence:
Social Security. Americans are overwhelmingly dependent on their government to support them in their old age – even millionaires.
“Indeed, 41 percent of older couples and 33 percent of singles would experience a living standard reduction of 90 percent or more were Social Security benefits eliminated,” says a recent study.
“A surprising finding is the major dependency of very high-income households on Social Security. Take the highest earning couple in our stylized sample. This couple earns $500,000 per year from age 30 through age 64 when it retires. It enters retirement with over $2.3 million in assets. But given the length of its potential retirement, the modest real return it can safely earn on its assets, its off-the-top housing expenses, and its tax payments, this household is highly dependent on Social Security benefits, notwithstanding their taxable status. Indeed, were this household denied all its Social Security benefits on the eve of its retirement, it would suffer a 35.6 percent reduction in its living standard throughout retirement.”
*** And here’s the latest mortgage scam – “equity stripping.” Of course, equity stripping is what homeowners have been doing themselves for more than 10 years. Until the early ’90s, the typical homeowner owned nearly 70% of his house, free of debt. Now, the figure is only 52%.
But now, as the housing slump deepens, more and more homeowners are faced with losing their houses. The American Bankers Association says that 19% of sub-prime mortgages are either delinquent or already in foreclosure. This has created a whole new mini-industry – helping people save their homes. Fast-moving finance companies read the published lists of houses entering the foreclosure process. They visit desperate owners, offering to restructure mortgages in order to prevent foreclosure. Then, they get owners to sign the houses over to the finance company, which strips out any remained equity – and then some. When the homeowners finally realize what has happened, they find themselves even deeper in debt…and the finance company no longer answers its phone.
*** Meanwhile, a dear reader writes:
“Hello, it is I again, Suzanne, the formerly twentysomething M.D. in Manhattan who engaged in some economic badinage with Bill some years ago. I am no longer in my 20s (sigh, what happens to fair youth), but I am still waiting for this great financial reckoning day that Bill has talked of endlessly since 1999.
“Recently, he wrote: ‘But when dim rock singers get into a trend, dear reader, you have to wonder if it isn’t already a little late in the day.’
“Bill, you have been saying it’s ‘already a little late in the day’ for almost ten years now, and still, no dice. Sure, there was a minor correction in 2000, and it lasted a few years, giving you some hope that finally the doomsday scenario you’ve been praying for for decades would come to fruition, but alas, your hopes have been dashed by this latest bullish run.
“Perhaps 40 or 50 years from now, when you are pushing up petunias and serving as fodder for night crawlers, the world markets will come crashing down, the dollar will collapse, and the Asians will come round to Uncle Sam demanding gold for their greenbacks; on that day, I’ll say, ‘Old Bill! He was a prophet! Everything he predicted, ’twas true!’
“Till then, you’re just a repetitive old windbag.
“And I’m just a thirtysomething doctor in New York, not as pretty as she used to be, trying to make sense of things.”
*** If we had our druthers, we might well prefer to be even a little-less pretty 30-something doctor in the Big Apple to being a 50-something windbag in London. But that is our sad lot in life…to repeat warnings, over and over again…and to grow older.
We sit at our post like a skull on the desk of a Renaissance scholar… a Memento Mori – yes, dear reader, there is death too, even in paradise…and yes…there are busts as well as booms…and yes, for ever silver lining, there is a cloud.
Why do we bother? Why not just knock it off? Why not just pull down our Crash Alert flag and admit that we don’t know when or how things will turn out?
Well, because we do know. No one is born of woman who doesn’t end in dust. And no bubble ever fails to find its pin. But when a man is young…and a bubble expands…who wants to focus on the downside? Not only is it no fun for most people, there is no profit in it either.
Only lonely relics…moral philosophers stuck in an immoral age…perma-bears in a perma-bull market… cranks and curmudgeons can bear to think about it.
Every day is a day of reckoning for us. But at least we enjoy them all. Vanity, pretense, hallucinations, dreams of grandeur and world improvement – it is all like cups of espresso to us…they open our eyes and make our pulse beat happily.
And if we take down our ‘Crash Alert,’ will you be better off, dear reader? Will you really be happier, more prosperous, and wiser without the irritating reminder that ‘this too shall pass’ flapping in the wind over your head? We don’t think so. Death, destruction, and desperation stalk us all. They do not come right out in the open and threaten. Instead, they hide in the shadows and behind trees, and dress up in alluring costumes – as stockbrokers and presidents, expert analysts and celebrity authors.
Is it really a waste of time when someone whispers to you – “watch your wallet?”
As for the dollar…well…it has lost about 20% of its purchasing power in the eight years we’ve been writing The Daily Reckoning, while our favorite metal, gold, has gone up 170%. Our dear reader thinks paper dollars will still be valuable 40 or 50 years from now; and maybe she is right. Who knows? Maybe the S&P will keep going up too. And by then, those of us who are still living will all be rich – running our own hedge funds…and doing private equity deals with each other.
*** Finally, we went out to dinner last night – husband and wife, out on the town in London.
“Yes, everything is changing for me,” Elizabeth took up the conversation.
“Now that the children are growing up, I need to find something to do with myself…without changing things so radically that our whole lives are turned upside down.
“I think what happens to many couples is that they are so busy with careers and children during the first 20 years of their marriages that they just don’t have time to think about themselves…and each other. It is as if they were climbing a long set of stairs…climbing together…carrying children…strollers…clothes…bags… You’ve seen these poor families going through airports with so much stuff…we did it ourselves when the children were young. And then, one day they get to the top of the stairs…and the children leave…and they look around…
“We know about four or five couples who have decided to split up. That’s what I think it is…they look around at the top of the stairs and decide they just don’t have much in common…or that they’d rather go off in a different direction. Some are bored. Some feel oppressed. Others just think they will get a better deal elsewhere.
“This really does seem like a new stage in our lives…a dangerous stage in many ways. But isn’t it great when people can arrive at the top of the stairs and find that they actually like each other? And then they have time to enjoy each other’s company…and to do something together. That’s why you see so many middle-aged couples holding hands, I think. After all those years of climbing stairs, they can now appreciate being together…and traveling…dining…all those things that the Hallmark cards promise…”
The Daily Reckoning PRESENTS: As Chris Mayer pointed out in Tuesday’s DR essay; railroads are back – in a big way. In today’s piece, Free Market Investor’s Christopher Hancock explains why America’s favorite investor fell in love with railroads…and why you should as well. Read on…
ALL ABOARD THE BUFFETT EXPRESS
Recently, Berkshire Hathaway Inc. disclosed its 10.9% stake in Burlington Northern Santa Fe worth $3.4 billion. To no one’s surprise, investors around the globe jumped on the Buffett express. Burlington’s share price rose 6.5% on the announcement.
And Buffett didn’t stop there. Berkshire confirmed it has also acquired stakes in two remaining North American railroads. The largest American railroads remaining are Union Pacific, CSX and Norfolk Southern. Our neighbors to the north offer Canadian National.
No one really knows why Buffett fell in love with railroads all of a sudden. Burlington certainly carries Buffett-like characteristics: consistent earnings growth (22% annualized over five years), impressive margins and limited competition.
But none of the railroads typifies your typical Benjamin Graham value play. The stock trades for more than 3 times book with limited liquidity and tangible debt.
So what was Buffett thinking? It’s anyone’s guess. But the prevailing consensus believes globalization – specifically, moving the major staples of trade (things like coal, oil, cars and clothes – in other words, basic commodities and finished goods) from producer to consumer – is the long-term trend at play here.
I’ll buy that.
It was about this time in 2002 that a rebirth in the tangible assets sector really began. Much of that growth can be directly attributed to the insatiable demand for raw materials that the developing giants China and India are now consuming.
These countries are still in the early stages of development. It takes about 30 years to go from an agrarian to an industrial society. China is about one-third of the way there. China will continue to import commodities to sustain this enormous transition. India will do the same.
Furthermore, the golden era of stocks (1982-2000) directed capital in about every investing avenue except natural resources and raw materials. Hence, limited demand caused a decrease in available supply.
Now the entire world can’t get enough copper, zinc, lumber and oil. But bringing on new production takes time. Supply can’t catch up with demand overnight. In fact, it’s going to take quite some time, especially when you throw the consumption potential of India and China (37% of the world’s population) into the mix. Consequently, commodities, the market for the essentials, will remain tight for the foreseeable future.
And commodity consumption won’t be limited to emerging markets alone. Let’s not forget that the United States has begun to embrace alternative energy. And the two greatest oil alternatives, coal and corn, are shipped by train.
So transport stocks like Burlington certainly play into this long-term trend. And considering that rising fuel prices affect trucks more than trains, this idea begins to make more and more sense.
But many feel it’s too late. Many believe the upside is already priced in. Well, that may be true.
You see, recently, Prudential, Bear Stearns and UBS all downgraded BNI to some type of peer perform/neutral rating. Most investors are now asking: Was Buffett wrong?
The key to that last sentence is the word “investors.” Most individuals who buy and sell shares are traders, not investors. These are people looking for a quick buck. The type of action that reflects an attitude more suited for the Las Vegas Strip, not the undying, underappreciated sex appeal attached to the $500 monthly deposit in the ol’ 401(k).
Without becoming too insipidly philosophical here, let me quickly say this. Blaise Pascal once said: “Most of men’s problems arise from their inability to sit quietly and alone.”
That’s a fair point. Actually, that’s a very good point.
It takes a rare soul to patiently sit on a $32 billion Korean steel stock when the daily headlines of even the most conservative publications saturate our brains with tales of highflying hedge fund managers making upward of $1 billion annually or A-list celebrities with nothing more than a high school degree receiving a $20 million payday.
But take solace in this. As Max Ehrmann wrote: “If you compare yourself with others, you may become vain and bitter; for always there will be greater and lesser persons than yourself. Enjoy your achievements as well as your plans.”
So if you’ve come here looking for a quick buck…I’m afraid you’ve come to the wrong place. If you expect services such as this to quickly make up for 20-plus years of inadequate retirement savings, maybe I can save you some time.
This is not a trading service, and this month’s pick won’t make you rich by Labor Day. In fact, I’m going to give you the valuation before I even start to make my case. I want to be straight from the very beginning.
Over the long term, I truly believe in this idea. Followers of Penny Sleuth will have heard this story before. It’s the story of transcontinental shipping.
The point is this: Shipping is, and will remain, irreplaceable on the world stage. We can’t live without it. It won’t be replaced. It’s been around for centuries. Until we reach a stage of technological innovation in which the major staples of trade – things like coal, oil, cars, the finished products that fill Wal-Mart stores – can be disassembled one molecule at a time and instantaneously beamed to another location, our current means for commerce will remain the most efficient.
for The Daily Reckoning
July 5, 2007
P.S. I believe dry bulk shippers offer a great long-term investment. I think they offer a very underappreciated way of piggybacking part of Buffett’s investment thesis.
My colleague, Chris Mayer, has also been looking at ways to profit from the renewed interest in railroads. If you would like to find out how to ride the rail boom – from every angle – look no further than the Agora Financial Reserve.
With the Reserve, you can get not only my insights, but Chris Mayer’s, Kevin Kerr’s, Byron King’s – in fact, all of the editors that you read here in The Daily Reckoning – for a never-to-be seen again low price.
Editor’s Note: Christopher Hancock has spent the last two years doing investment research primarily focused on emerging markets, specifically China and Hong Kong. After working with Citigroup in Hong Kong on the challenges and opportunities associated with the forthcoming RBM flotation reform, Christopher left many of his friends behind and decided to return to the States to pursue a career in equity research.
Christopher’s desire to work for an independent firm led him to Agora Financial, where he now is the editor of Free Market Investor. Christopher travels extensively and utilizes his contacts across the globe to recommend the best international investments in the world right now for his subscribers.