Thursday, August 31, 2006

Fork in the Road, Reprised

On a quiet Friday afternoon about a week ago I tossed out a humble observation I referred to as a fork in the road.

The NY Times has picked up the same theme and expanded on it. But A Forecast for a Fork in the Road is much more important than my rather vague feelings, for that author thought to check in with the very smart folks over at ECRI.

For those of you that are bullish- and tired of hearing all these nattering naybobs- I would still encourage you to keep an eye on what the people at ECRI have to say. Not just because ECRI's crystal ball seems to be of higher quality (which I think it is), but because anyone loaded for bear still needs to keep an eye out for the market's elephants (which just happen to be ECRI's clients).

Wednesday, August 30, 2006

MEGO numbers (My Eyes Glaze Over)

Years ago I volunteered to teach classes for Junior Achievement, where they send business people into the classroom to teach kids about finance and the economy. About that time the national debt had been in the news and the teacher asked me to explain it to her class.

Back then it was a staggering $4.5 Trillion.

Don't know why, but I thought it would be fun to write it on the board in big letters.


Took up the whole wall... but all I got were blank stares.

So I wrote the amount each of them owed.


For the first time those kids were sitting straight up in their chairs, arms and hands reaching for the ceiling, pleading, "pick me! pick me!" Nothing we'd covered, including the popular stock market game, ever got that sort of response.

Meanwhile, Julio sat on the front row with his arms crossed staring at the board the entire time. Julio was in deep serious thought.

As my time ran out I asked if anyone else had any questions.

Up goes Julio's hand.

"So you're sayin' America owes all this money?"

"That's right."

"And you're sayin' each of us have to pay $16,000, or you sayin' my mom and dad have to pay that?"

"That is the amount all of us owe right now. $16,000 is yours, mine, your mom's and your dad's. We don't have to pay it right now, but..."

"You're saying I owe $16,000?"

"Yes, that's your share."

"Sheee-it. I ain't payin that!"

The school bell rang, but was drowned out by the bell ringing in my head. I drove back to the office stunned. I knew at that moment that some day that kid will be United States Senator Julio. And some day Senator Julio is going to introduce a bill. And when he and his classmates get together, Social Security and Medicare will no longer be the "third rail of politics".

I was reminded of that story recently when David Walker, Comptroller General of the US, gave a speech explaining that we still don't get it. In fact, we aren't even using the right numbers.

What used to be $4.5T... is now $8.5T. But that is just the national debt on the books.

Terry Savage's article in (where I shamelessly stole that great headline) quotes a study done for the St. Louis Fed:

...economist Lawrence Kotlikoff pointed out that the U.S. is responsible for $80 trillion in future entitlement promises -- a figure about six times larger than the U.S. economy. To make good on those promises, future workers would have to pay tax rates ranging from 55% to 80% of their incomes!

The same week that Kotlikoff's study ran in the Federal Reserve Bank of St. Louis bulletin, the comptroller general of the U.S. said, "Current fiscal policy is not sustainable, and hard choices must be made ... we're mortgaging the future of our children and grandchildren and creating a shameful legacy."

Using those numbers Senator Julio now owes $156,000.

Memo to CNBC

This morning I broke one of my longstanding rules and turned the volume on to check out Squawk Box and Morning Call. As usual, actually listening to what they're saying on CNBC proved to be a complete waste of time.

Memo to CNBC

Mark: drop the phony enthusiasm. We liked you better when you were providing some
adult supervision and/or making cynical faces at the camera. If you are required to pretend to be happy with a fractured hour from the floor of the exchange you should just quit.

Ladies (you know who you are): the Dow Jones Industrial Average is an 11,000+/- point index composed of 30 individual stocks whose prices change every second. A change in the index from minus 9 to plus 6 is not a reaction to anything. A move of .1% in the first hour of trading is also known as flat. A rounding error. More importantly, a 30 point change off the flat line is not a "surge". In other words, going from 1/10 of 1% to 1/4 of 1% is just noise on a quiet summer day.

Joe: a stock that is bid 23 cents below yesterday's close in the premarket is not reacting to [insert news]. It is still not reacting to [insert same news] when the market opens and the stock is up 11 cents. That is especially true for a $90 stock. But you already know that, right? So we have someone feeding the teleprompter that does not?

Bob: you seem like a nice guy... but it would be good if you could bring something to the table. More than anyone, anywhere, you have unfettered access to specialists on the front lines. Yet we get nothing except the same exact cliches day after day after day ("Traders I've talked to are watching oil... Traders say pay attention to interest rates..."). Bob, you aren't really talking to traders are you? C'mon, just between us. Those bullies picking on you again? Do me a favor. Just as an experiment. Grab one of those guys walking by (trying to avoid eye contact) and ask him what's really up. "How's the tape feel today?" "What's really new out there that nobody's talking about?" "Hey, explain to our viewers what it is you guys are doing jammed into that post over there!" If you're telling me you can't do anything like that, then you're just using the exchange floor for wallpaper.

Rick: you are a god. Not because you provide more information in 45 seconds than the
entire cast manages in an hour, but because you so diplomatically deflect their lack of understanding when they throw it to you. We know why you're always smiling with all the crap you have to listen to before it's your turn. By the way, please talk to the traders on the NYSE floor and ask them to be nice to Bob.

CNBC: your website is awful. Literally worthless. You are a wholly owned subsidiary of one of the most valuable companies on the planet. Yet I can't watch an interview with a guy from last Friday (worse yet, according to your search function, there is no record this regular guest exists). Both confirmed by a painful phone call with a robot in viewer services (by the way, I had to help her find the site first). Ever heard of YouTube? Check it out. See what I mean? Why is it I can watch the I Love Lucy Show from 1957 but can't watch an interview from last Friday?

Monday, August 28, 2006

Actually, the Glass is Full

Over at the Big Picture, Barry Ritholtz has been all over the important story of rising corporate earnings vs. compensation for as long as I've been visiting his blog it seems, so I'm going to direct your attention to two related posts, here and here (I had saved both articles as a draft for further comment this morning, but as usual I found he'd beat me to the punch).

That chart is hard to see because I copied it from Barry's site. The original, along with a few pages full of other informative charts is available at the St Louis Fed's website (see esp Productivity and Profits).

Obviously US corporatons have achieved peak earnings in this cycle in no small part due to impressive gains in productivity, even as total compensation has dwindled. Which raises a profoundly important question: what do you do for an encore?

Look closely at that chart. People are not going to work for free.

And even if you think it's different this time , and we have reached a new plateau of prosperity, the stock market wants more. Record gross margins and cash flow soon become next years challenging comparisons.

Those of us concerned about the housing market serving as a canary in the broader economic mine consider Exhibit A to be the homebuilder stocks themselves. None of those companies are losing money. None of them are anywhere near bankruptcy. They were NOT expensive stocks a year ago, when trading at 11 times earnings.

Yet the sector has suffered a 50% haircut in the past 12 months.

Most Emailed Articles At a Glance

The NY Times (free registration required) has a feature I use constantly when surfing the web looking for something good to read. The Top 25 Most Emailed Articles has proven to be a terrific source of all sorts of interesting articles that a bunch of people found good enough to take the time to email to someone else. Chances are you'll find something worthwhile, no matter what mood you're in.

In addition, the Wall Street Journal (sub required) has a similar feature, At A Glance, which is organized by topic.

All Real Estate is... Global?

Real Money contributor and ING Resident-Guru Jim Griffin wonders if all the talk of a housing implosion might be blown way out of proportion.
There has been quite a lot of concern about the housing outlook lately and its likely negative effect on the broader economy... But much of the argumentation strikes me as what-goes-up-must-come-down determinism; narrow in focus, divorced from context, and moralistic in tone.

More importantly, he reasons, the housing bears could be missing what might be a global phenomenom that kicked in around 1990.

It’s almost as if something changed back around 1990, and something surely did: a list might include the collapse of the Soviet Union and a Cold War peace dividend in the form of a shrinking federal budget deficit [Note: as a percentage of GDP], the missteps of Japanese economic policy, and the Teutonic austerity in Europe as it strove for monetary union. The emergence of China and other newly capitalist economies might also be penciled in.

And if that is the case, then the economic bears might be missing out on what could be a longer economic cycle.
If we were to want to spin the analysis in a positive direction, we could make a case that the business cycle – a new more fully globalized version and not the closed-economy shorthand model – has reached the self-sustaining phase that in past cycles caused the monetary authority to withdraw accommodation and strive for neutrality. If the case has merit, it implies a much longer expansion phase – it took a long time to get out of first gear – with the further implication that today’s worries about a 2007 recession are overdone. I don’t want to pound the table on that argument because there hasn’t yet been a full cycle, both up and down, within the globalized economy yet and I’d like to have a bit of real world experience before getting too cocky.

There's a subtext worth careful consideration whether you agree with Mr. Griffin's thesis or not: there are indeed aspects of this cycle that have confounded a great many thoughtful people. Well, what if the market keeps going up even as the doomsday drums get louder and louder? How many of us are hardwired to admit we were wrong?

More importantly, to paraphrase a constant theme voiced by Rodger Nusbaum, what if you totally believe the market will crash and you go 100% cash- or you sell your beautiful home and rent an apartment- and it turns out... you're wrong? Then what?

Sunday, August 27, 2006

Hussman's Weekly Commentary

John Hussman raises his target for the Dow to 15,000.

Just kidding.

As usual, John Hussman's commentary is a worthwhile read.
With recession signals increasing (though not yet enough to predict a recession with a high probability), it's useful to remember that stocks generally turn lower before the economy, with a lead-time of about 6 months. That may very well be the window we've entered here.

On the economy, the most recent data on housing starts continues to confirm a downturn in housing, which was also evident in the 4.10% drop in new home sales last month. That gives us a new point on our housing starts oscillator, which is already at a level consistent with potential recession.

One of the things I like about John Hussman is his knack for maintaining objectivity. He's been cautious for quite some time, yet he tends to express it in unemotional terms. For instance, he doesn't suggest everybody sell and head for the hills- but he minces no words either:

The major indices remain extended in an overbought condition, which in unfavorable Market Climates tends to give the markets a downside bias. Still, it's important to remember that even unfavorable Market Climates allow for short-term advances – it's just that the average return/risk profile in such Climates tends to be unfavorable.

Saturday, August 26, 2006

NY Times: Whispers of Mergers Set Off Suspicious Trading

I recently observed the interesting coincidence in the sharp rise in ISSX leading up to a cash offer from IBM.

Now comes a lengthy report, from Gretchen Morgenson, and a crack team of investigators, who were apparently shocked- SHOCKED!- that after all these years, and despite all the publicity from so many scandals, people still trade off inside information.

The public must be wondering why we can put an unmanned robot on Mars yet we need a private investigation by the NY Times to finger insider trading.

The truth is the Feds deal with insider trading the same way the IRS deals with people cheating on their taxes: nail a few high profile cases once in a while, stick a few people in jail every so often, and hope the fear of prosecution will keep a lid on it.

Oldies But Goodies

I went back and found two articles that have stuck with me over the years.

The first was the earliest very public warning of recession after the Y2K bubble popped. Re-reading this piece in light of the current price at the pump is sobering to say the least.

The economy's humming along, no more interest-rate hikes are in sight, and the markets are starting to feel comfortable again after the inflation scare... Why worry?

I'll tell you why. The fact is, throughout the last 50 years, there has never been a spike in oil-price inflation of this magnitude without a subsequent recession. That's right -- never. And a spike in oil-price inflation preceded almost every recession.
Call it the Oil Recession
Anirvan Banerji

On a brighter note, the second article is a stunning interview with Sheikh Ahmed Zaki Yamani, the former chief of OPEC credited with being the architect of the painful oil shocks of the 1970's. The good news: Sheikh Yamani predicts oil prices will crash; the bad news: he said that back in 2000.
OPEC has a very short memory. It will pay a heavy price for not acting in 1999 to control oil prices. Now it is too late.

The Stone Age came to an end not for a lack of stones and the oil age will end, but not for a lack of oil.
Yamani says OPEC accelerating end of the oil era
Reuters (via planetark)

By the way, I think they're both right... and if we get a really big spike in oil the Sheikh will look prophetic in the future.

Friday, August 25, 2006

Fork in the Road

Every once in a while we reach an economic point that gives me a profound sense of standing at the proverbial "fork in the road".

I remember talking to clients back in early 2003 of having that same feeling. According to the Fed, and a lot of other very smart folks, we were standing at the edge of a deflationary abyss (certainly not a good thing for stocks). Yet the market had taken off and put in a higher low, gold and other commodities (inflationary red flags) were moving up, and so on. Meanwhile, interest rates had plunged to 45 year lows.

As I summed it up at the time: SOMEBODY is very wrong here.

Turned out to be the Fed and all those smart bond traders: after about a 20 year bull market in bonds we reversed course and yields moved sharply higher; and after 50-80% declines in the stockmarket, between 2000 and the end of 2002, we enjoyed a ferocious rally.

As summer winds down I get a similar feeling.

On the one hand the Fed is telling us inflation won't be a problem- because the economy is slowing (certainly not a good thing for stocks). The bond market has bought into that line of thinking across the inverted yield curve.

Yet the stockmarket has been hanging tough, climbing that wall of worry, and commodities are still very high- including oil, which has one eyeball on Iran and now the other on Tropical Storm Ernesto.

Not to mention all the handwringing over the housing market (and what impact that might have on the broader economy if we lose that leg of the stool).

Seems everyone has a full plate of scared, right?

Not really. The volatility indexes hit the snooze button this summer and rolled back over. And to my surprise I've seen a half dozen charts that measure various forms of fear that look the same.

Honestly, I think everyone, including the Fed, is idling at said fork wondering what to do next. We're watching for hints about 3rd quarter earnings, waiting for the next set of inflation numbers, talking to our friends and family about the housing market, and worrying about plenty. But nobody wants to go first.

But no matter your bias... SOMEBODY is very wrong.

Update (Aug 26): Bill Cara ponders the fork in the road, or as he calls them, "crosscurrents", in his detailed week in review. Interesting to consider the relationship between the stock and bond market over the past few months.

Worried about real estate in this country?

There has been an explosion of commentary in the blogosphere on the housing situation, in addition to what is showing up in local newspapers all over the country.

There are numerous blogs out there devoting all their energy to the subject (one such blog has entry after entry after entry of links to scary articles).

But for those interested in what this may mean for the broader economy I'd recommend perusing the Big Picture. Scroll down and/or check the archives and you'll find a ton. Call it a macro view.

And for those looking for more practical information... say, you're selling your own home... check out multiple articles and links found on Larry Nusbaum's site.

Good stuff.

Wednesday, August 23, 2006

Junk Bond Bubble

There has been quite a bit of research and analysis done on what has been called "rolling asset bubbles" (search the phrase and you'll find more than you can read on the subject).

I'm intentionally avoiding the various debates about whether or not this or that asset class is technically sporting a bubble, because the point here is to offer a heads up about the next disaster in the wings.

Most agree the "Y2k bubble" got the ball rolling. As the air came out there was a lot of money that went looking for a home:

  • Commodities
  • Real Estate
  • Emerging Markets
  • High Yield (Junk Bonds)

Each asset class has its own peculiar characteristics, and each has a history of cycles-- some more severe than others.

The stock market bubble popped (ie, the Nasdaq declined 80%), the Fed threw real estate under the bus, certain emerging markets have been hammered this year... but what gives with the junk bond market?

Credit spreads remain razor thin.

Frankly, there are a dozen great explanations out there as to why junk bond yields remain so close to risk free alternatives. But wading through all of that is a waste of time.

Using common sense will work just fine in this case. I'll illustrate what I mean using two examples:

The DooWop High Yield Fund (not going to use the real name of the fund here), with an average maturity of 10 years, currently yeilds 5.8%. Meanwhile, the ten year US Treasury yield is 4.82%. That means you're getting one lousy extra percent for a basket of high risk bonds issued by companies with low credit ratings.

Here's the problem: as recently as 4 years ago credit spreads traded 5-10% ABOVE treasuries (depends on which index you use). There have been extreme cases where those spreads spiked even higher. Thus, it is possible for junk bond prices to plunge even if the yield curve remained static.

This leads me to an anecdotal example. I have recently succeeded on a large account for an elderly couple well into their 80's. One of them has been in a nursing home for the past few years and unable to make even the most basic decisions for himself.

Long story, short: their financial advisor had loaded the boat on junk bonds.

Even if you were to explain all this to them they would not understand. Frankly, credit spreads, interest rate risk, and so forth, are just too complicated.

But that is only the most egregious example. I am not only seeing prospective clients with too much junk, but I know advisors that are still making a case for "overweighting" (using that term to be kind).

The reality is these folks are not leavening a portfolio due to an asset allocation model that argues for X% in a high yield basket. These are real world people simply reaching for yield aided by aggressive advisors selecting the funds from the best performing asset classes (using 1,3, and 5 year returns).

And you can take this entire discussion and apply it to preferreds (think about all the Ford preferreds floating around out there), REIT's, and any number of other creations that offer a higher yield through a basket of something that is much more complicated than nearly every retail client will honestly understand.

When the tide goes out again- which it certainly will- there will be an avalanche of supply coming from investors that had no clue about what they owned in the first place.

IBM (IBM) buys Internet Security Systems (ISSX)

There's a service out there that captures unusual option activity for a given day and produces a top ten list of sorts. I seem to recall ISSX popping up a week or so ago due to active call buying. Didn't give it much thought at the time because I'm not involved. But when the news broke this morning I got curious about that amazing coincidence.

By the way, message boards are the last place on earth you want to look for research and analysis... but interesting to peruse a few this morning that provided some uncanny details just last week.

They say a picture's worth a thousand words, so I'll just direct your attention to that huge reversal on the right hand side of that one year chart.

Tuesday, August 22, 2006

Options Scandal, Part II

Bloomberg has a story out about United Health's CEO and Board of Directors accumulating $2 Billion (I've rounded down) in stock, mostly due to stock options:

UnitedHealth Group Inc. Chairman William McGuire sparked outrage among some stockholders over his $1.8 billion in potential stock-option gains. Turns out, the board of directors that granted those options got a share of the wealth, too. UnitedHealth's 10 non-executive directors held $230 million in stock as of March 21, according to the health insurer's most recent proxy.

A company spokesman tried to put those numbers in context. For example, a big part of the size and scope of those holdings reflect the fact that the stock has been a fabulous investment (up 7,000% during the CEO's tenure). Also, the folks with the largest positions accumulated their stock over a long period of time.

I've got no problem with that. If you invested or were granted a sum commensurate with the job- or maybe you just got lucky, being in the right place at the right time- and now the stock has gone up in a meteoric fashion, hey, that's the American dream...

... uh, wait... hold on... it might turn out to be more than luck.

Once again, the more you read the more complicated it gets:

UnitedHealth yesterday said it delayed its second-quarter earnings report while it determines whether it will have to restate results because of inappropriate options accounting. A board committee is reviewing 45,000 separate option grants made to 15,000 people over 13 years, the company said in a statement.

UnitedHealth shares fell $1.65, or 3.4 percent, to $47.33 at 4 p.m. in New York Stock Exchange composite trading, bringing their decline this year to 24 percent. Standard & Poor's Ratings Services revised its outlook for UnitedHealth to ``negative'' from ``stable,'' and A.G. Edwards & Sons Inc. downgraded the stock to ``hold'' from ``buy,'' citing the filing delay.

The step ``is significant evidence that there are real problems with United Healthcare's stock-option accounting,'' said analyst J. Paul Newsome in St. Louis in a note to day. ``It also increases, in our view, the likelihood that its well-regarded CEO will be pressured to leave.''

And as I've said before, it's not just bookkeeping errors... we now find they gave the CEO the equivalent of a blank check each time options were awarded:
Critics cite one board policy: McGuire was formerly allowed to pick his own option-grant dates. His Oct. 13, 1999, employment contract says: ``The annual options shall be granted on such date or dates as executive requests by oral notification to the chair of the compensation and human resources committee.''

So now investigations have spawned more investigations, as well as an internal probe. And this time the big shareholders are filing lawsuits.

Meanwhile, despite the company's vigorous defense of the program, they are cutting and/or dumping a long list of benefits:

After the revelations in April about McGuire's options, the board revised its own pay policies on May 1, reducing its compensation by 40 percent. That came on top of a 20 percent reduction in the number of options they could get after the shares were split, in May of last year. The board also discontinued equity grants to McGuire and other executives, capped supplemental retirement benefits for the executives, eliminated perks like life-insurance premium payments and set the annual meeting as the grant date for all options for existing employees.

This raises the same questions all over again: was it fair and responsible? Does anyone expect the internal probe to turn up "bookkeeping errors" that favored the shareholders?

Monday, August 21, 2006

Does the Bond Market Have it All Wrong?

Over at one of my faves, the Big Picture Blog, Barry Ritholtz asks: Does the Bond Market Have it All Wrong?.
I have been fond of saying that the equity traders are the hormonal teenagers of the capital markets (traders think of markets as a daily version of Hot or Not?).

In our metaphor, the Bond market is the so-called adult supervision. Bond vigilantes have long been thought of as applying much needed pressure to the Feds to keep inflation under control, and rein in the deficit spending habits of the Federal government.

Implicit in this discussion: "Dose the Federal Reserve have it all wrong?"

Of course nobody knows the answer yet, but we don't have to travel very far to find an example of when both were very wrong:

That's a chart of the yield on the Ten Year US Treasury. Not only do you see a dramatic spike from 3.80 to 5 1/4% (about a 40% jump in rates), but what you don't see is the previous dip to the neighborhood of 3% back in 2003.

Three years ago the Fed was warning of DE-flation and reassuring the markets that they had plenty of tools available to avoid Japan's policy mistakes (what some have called Japan's economic depression).

A year ago certain members of the Fed were confidently predicting oil and other commodities would decline, and that inflation was well under control.

Keep in mind as you look at that chart the dollar value of the treasury bond market is absolutely enormous. Thus, relatively small changes in yield translate into very large gains/losses. In addition, there are countless loans and other instruments pegged to various yields along the curve.

In other words, a whole lot more at stake than just what it costs the government to get a loan.

Thus, the more cerebral types (think: Bill Gross) inhabit the bond market trenches, and as an extension, the bond market get it's reputation for being the more reliable leading indicator.

The truth is the bond market can be every bit as volatile as the stock market, and some would argue the Fed's crystal ball has been in the shop for quite a long time now.

Saturday, August 19, 2006

Things that make you go "Hmmmm"....

After such a nice run (since June/July lows), I've seen a stack of articles and reports predicting:

  • Fourth quarter rally (they vary from the "run of the mill" to the "blast off" variety)
  • New all time highs for the major indexes
  • Rebound in home sales/home prices
  • Double digit earnings growth for 2007
  • Leadership in large caps leading us higher
  • Resurgence in small caps leading us higher
  • Price to Earnings ratios "will expand from current 15X's to 16.9X's"... get the idea.

Let's look at the foundation this future rally might be built upon:

  • 17 consecutive quarters of double digit earnings growth
  • Record Fed/State/Local tax receipts (considered a good measure of the total economy)
  • Risk premia and credit spreads razor thin; volatility indexes at multi-year lows
  • Unemployment at 4.8%
  • Home ownership rates (a measure of economic health) highest in history
  • High rates of productivity keeping inflation and interest rates relatively low

Considering that's just a representative list, I'd have to say the bulls have a very strong foundation.

But you know... there's one question that keeps nagging at me:

If everything is so fantastic, then why are we still deficit spending in this country like a bunch of drunk sailors?

Not just the Federal government, but individually as well?

Think about it: I'm not asking why we can't seem to "get ahead"... I'm asking why we can't even slow down!

More importantly, if we can't keep up with our spending during the best economic conditions in the history of the planet, then when will we ever be able to pay off our debt?

Note: I'm not even touching the "offbudget" Iraq/Afghanistan/Katrina spending, nor the Social Security/Medicare/Pension unfunded liabilities.

Thursday, August 17, 2006

Options Scandal

The more you read about the Options Scandal the more complicated it gets. So let's try breaking it down with the help of Network Appliance CEO, Daniel Warmenhoven, using this interview with Businessweek's Peter Burrows.

I think the government is looking to... publicly hang people... That's fine. But where does it stop? I'm not saying the past practices were all good. But I thought the SEC's role was to build investor confidence. What they're doing right now is destroying it, and I don't see the purpose. They're penalizing today's shareholders for events that occurred five years ago. But who is this protecting, exactly? With Enron, every shareholder in the company lost money. The same with Qwest, and with MCI-Worldcom. But I don't know who the injured party is here.
Mmmm Hmmm....

Probably for sake of brevity, Peter Burrows doesn't point out it's actually the CEO/Board of Directors who are responsible for investor confidence. Instead, he just kindly explains that investors didn't get the same sort of special deal available to insiders. Then he lets loose an open-ender, wondering why are so many companies in so much trouble?

This is going to sound weird, but what difference did it make [if the options expense was recorded on company's official financial records using generally accepted accounting principles, or GAAP]? It was going to be removed for the pro forma reports anyway, and that's all the investment community cared about. And there was no rigor around the enforcement of this [by the SEC]. I'm not trying to defend the practice. But [properly disclosing and expensing in-the-money options] just wasn't viewed as a high priority by anyone. It generally wasn't even audited by the audit firms. The view was that close enough is close enough, which is why some people crossed over the line.
Alrighty then.

As you know, you have to be really smart to get a job with Businessweek, and Peter is a good example of that. So he ain't done with this fella by a longshot. Later in the interview he tricks Mr. Warmenhoven, wondering what a CEO could do to protect shareholders.
There was a lot more focus on the number of shares we granted than on the price.The number of shares is what creates dilution, and we manage the number of shares being granted every year within a dilution cap. Every year, I talked to my big shareholders and asked for their support [for the year's options program], and explained to them in great detail what the options will be used for...

OK, so probably not the best person to explain the industry's perspective afterall (by the way, in case you don't have time to read the whole interview, he continues by describing the ways regular people like us are speeding and nobody does anything to stop that either).

All kidding aside, this scandal rubs people the wrong way because the whole point is simple fairness and responsibility.

And this is not a question about what the market will bear. You'll never see me complain that Cisco's John Chambers gets $149,000 per day from his totally legal and publicly disclosed options contracts... even though the stock has gone nowhere for 8 years. (I should point out it's not a real market when you and a few of your golfing buddies sit around the table and just make stuff up.)

But honestly, the real reason for this rant is not about the options scandal, per se. The big revelation here can be found if you direct your attention to the humongous investors Mr. Warmenhoven checks with for legal and accounting advice.

Turns out you've apparently got the blind leading the blind, because those institutions are a bunch of morons.

Witness: while a lot of these big institutional shareholders have been keeping track of those "dilution caps", with a wink and a nod, their option-happy CEO's have been shoveling the company's cash into stock buybacks. (Note: Cisco apparently had a different approach: they are spending some $40 Billion after years and years of dilution.)

At the same time those CEO's and other insiders have been selling stock all the way down (that's the beauty of options awards: it's all relative. If a stock goes south, from, oh I don't know, say, $150/share to $5... before getting back to $32 and change, you just keep getting new awards with lower and lower strikes-- a good deal whether or not there's a "look back").

Having said all that, here's why I don't get too upset about such things: eventually the other investors in those aforementioned BIG INSTITUTIONAL FUNDS will take their money away, and in turn Adam Smith's invisible hand sweeps away the greedy CEO and their lazy Board of Directors.


An editorial in Sunday's tech friendly San Jose Mercury News, Reality of stock-option drama is most errors were unintended, picks up on the theme that the options scandal is not much more than bookkeeping errors.

Yet still missing from very nearly every piece of analysis is the issue of favorable treatment granted to insiders vs the existing owners of the company.

Put another way, even if it's technically legal, was it fair and responsible?

Before you answer, think about this: can you imagine the shelf life of a systemic, industry-wide bookkeeping error that screwed executives and/or new hires of said companies?

The Stock Market is Going Up... uh, Right?- Part 2

I mentioned previously the importance of critical thinking. Today we have Exhibit A from one of the very best newspapers in the known universe.

In this morning's Heard on the Street column, Gregory Zuckerman lays out a case for higher stock prices based on a recent "borrowing binge" by US corporations.

...the [increased borrowing] could help the stock market deal with an expected slowdown in profit gains later this year as the economy contracts. That is because both higher dividends, and buybacks that raise earnings per share by reducing the number of outstanding shares, could help offset any decline in profit growth.

The rate of increase in debt is certainly a concern, and the use of those funds by some companies trying to goose their stock prices is troubling, but to jump to a conclusion that as a result the stock market will go up is... ludicrous. The total market cap here in the US is enormous compared to even the most generous projections of new debt being issued- even if we were to assume that every new dollar of debt was dumped into the market.

Analysts and investors are compiling lists of companies with relatively clean balance sheets and steady cash flows that could find themselves attractive as leveraged-buyout candidates, which depend on adding debt to a target's balance sheet.

The author also stumbles into a sorta semi-related point that has received a fair amount of attention recently: the surge in private equity funds taking public companies private. Several potential targets are named, and several experts are cited adding fuel to the fire.

But like any journalist with two good hands ("on the other hand..."), we are reminded none of this may happen.

The rosy debt scenario is predicated on an economy that doesn't weaken significantly, and on interest rates not climbing much higher, both of which would make the increased debts more of a burden. It all comes at a time when individuals and the U.S. government are dealing with their own heavy borrowing, making it more important for U.S. companies to successfully handle their added debt.

It's fun to ramble on about takeover candidates, and if you throw enough examples out there you're liable to look smart when one of them gets taken out. But what of the giant pink elephant in the room totally ignored in this piece?

The "wave of leveraged buyouts" is mostly due to the easy credit (razor thin credit spreads) sloshing around the system, much of which is making its way to PE funds and the like. And why are they so interested in buying up everything in sight when everybody and his brother seems to realize the economy is slowing down? Well, that is largely due to their understanding that the credit spigot will be shut off if the current trends in the economy persist-- especially if those unwelcome trends accelerate.

Finally, what does this say about today's investors, and the companies they invest in, when there is apparently "pressure from shareholders for larger dividends and share buybacks", without a care in the world about the consequences?

Wednesday, August 16, 2006

JonBenet Ramsey

What does JonBenet have to do with investing?

Absolutely nothing.

But the story has everything to do with what's wrong with the mainstream media.

Tonight I checked each cable news channel and every single one of them was wall to wall "JonBenet"- including CNBC, which had two guys yelling over each other.

There's a more important illustration here that sticks out like a sore thumb: with the way the financial media covers news you feel like you're on a pogo stick on a treadmill.

Worse yet, like the bozo's yelling over each other on CNBC tonight, there's plenty of wild speculation about something none of them can predict and that none of them appear to truly understand (the handling of the jobs numbers come to mind).

And this doesn't even begin to address the Jim Cramer circus.


Tuesday, August 15, 2006

The Stock Market is Going Up... uh, Right?

You should always try to find good bullish AND bearish analysis. You're better off giving weight to something rigorous, but it's also interesting to examine the process used to support the conclusion. In the grand scheme of things the former may be a mere data point; but the latter is important in order to develop critical thinking.

Then again, every once in a while you'll stumble upon an author's analysis that reaches a definite conclusion that... well, leaves you scratching your head.

Recession has once again taken a place in market chatter. The market’s mood, the slide into slump by the housing sector, the yield curve’s on-again, off-again flirtation with inversion, the Fed’s campaign (unpunctuated until last week) to reel in the monetary line it had previously played out – all make good talking points for the recession case. Nevertheless, I don’t find them convincing.

RealMoney Contributor and ING Resident-Guru, Jim Griffin, in his weekly piece, is clearly bullish. But if you read his analysis with a little history in mind it makes you think he must have accidentally merged two different articles.

Mr. Griffin has unintentionally revealed some scary parallels to the markets of the late 60's and mid 80's.

To be specific, he soothingly strolls through a few numbers and charts-- essentially saying, "Hey, the damage is already done!"-- but upon reflection he's picked two historical points (and a really ugly chart) that will make you spew your morning coffee.

As a reminder, investors piling in during the late 1960's didn't get their money back for 14 years; those investing at the bottom of that "mid-1980's" divot got beat up in the 1987 crash about the the time their trades settled.

By the way, let me say right here, right now: I LOVE Jim's stuff; he's always got that cool breeze view of the world that comes with a lot of experience during a lot of ups and downs. And it's not just a great writing style; he also has a gift for looking through a lot of market noise.

So not picking on Mr. Griffin. The main point is to illustrate the complexity involved in making long range forecasts using what may appear to be historical parallels. Put another way, a lot of smart folks could rewrite his essay using the same numbers and charts and offer a valid conclusion that is completely opposite.

Encouraging Echoes of Cycles Past, by Jim Griffin,0,w