Vector Money Management

August 19, 2010

Mid-August Outlook and Portfolio Design

Filed under: Market Comments,Outlook — vector @ 2:29 pm

The financial markets continue to struggle with what we consider to be irregular conditions – record low interest rates, record high gold prices, record government borrowing, record government spending and a 9.5% unemployment rate.  At times like these, it is crucial to understand, as best you can, the real situation and not default to a standard plan developed for more normal conditions.  The real situation, as we see it, is that the U.S. economy is slowly recovering from the financial crisis of 2007-08, a crisis caused by a gross misallocation of capital into residential and commercial real estate.  The reaction of government policy makers from both parties has been to focus on minimizing failure – from the largest organization to the individual home owner.  The unintended consequence of their (often ad hoc) actions has been to create an unusual and unproductive policy mix (monetary, fiscal and regulatory) that is severely limiting the expansion of the economy during this recovery period.  With little foreseeable change in the current predicament, we have focused our “portfolio design” process on sectors, industries and companies that stand to benefit from opportunities outside the U.S. where economic growth is much more robust.

 On the Defensive Side:  This is the most challenging period we can recall when it comes to preserving capital while also generating a reasonable return.  There is a growing debate over whether Inflation or Deflation is a bigger risk.  Both can wreak havoc on investment portfolios, so the issue is a crucial one for investors.  We have focused on and studied the issue for a long time and it is our considered opinion that Inflation is the much more likely outcome of the current policy mix and, thus, rates as the more serious risk for investors.  The U.S. Treasury Department and the Federal Reserve have run a weak dollar policy for almost ten years and there is no indication that they will adopt a strong dollar policy any time soon.  It is no coincidence that during this weak dollar decade the Periodic Table of Elements (metal commodities) has easily outperformed the S&P 500 Index.  For these reasons, our portfolio design continues to include a significant weighting in natural resource related companies.  A weak dollar is a tail wind for the businesses of these companies, so they provide some hedge against the risk of rising inflation in the months and years ahead.

   Continuous Assessment: The upcoming election on November 2nd could very well shake up the policy mix coming from Washington, especially in the fiscal and regulatory arenas.  More certainty on the issue of future tax rates could be an important catalyst to putting some of the $2 trillion on corporate balance sheets to work in the U.S. economy.  The latent potential of the American entrepreneur should not be underestimated.

 If you have any questions or feedback please let us know. 

 Ashby Foote

July 21, 2010

“What’s Hot and What’s Not” Presentation at MTA Discovery Luncheon

Filed under: Presentations — vector @ 9:20 pm

On Tuesday, July 13th, I was honored to be the guest speaker at the Discovery Luncheon sponsered by the Mississippi Technology Alliance (MTA).  I was asked to prepare an updated version of a presentation I had done in Novemeber of 2009, addressing various paradigm shifts and aptly titled “What’s Hot – What’s Not.”  The thrust of the comments that accompanied the power-point slides was that paradigm shifts matter mightily to investors and entrepreneurs – get on the right side of one and you can make above average returns – get on the wrong side and you can lose your shirt.  Hot new trends, products or services aren’t necessarily paradigm shifts themselves but can often be early indicators of paradigm shifts underway.  To get a better understanding of my thinking for each slide, I’ve uploaded my ‘talking points’ for each slide here.

Ashby Foote

July 26, 2009

Primer: Cap and trade – Waxman-Markey cap and trade bill can ‘sink a big chunk’ of the U.S. economy

Filed under: Newspaper Articles — admin @ 4:20 pm

Ashby M. Foote III
Contributing columnist, The Clarion-Ledger

You may have missed it in the blitzkrieg of legislative action the past few months, but if you intend to purchase gasoline or electricity in the years ahead, you had better burn some midnight oil on House Resolution 2454.

“The American Clean Energy and Security Act” (HR2454), also know as the Waxman-Markey cap and trade bill, passed the U.S. House of Representatives on June 26 by a vote of 219 to 212. That two House barons like Henry Waxman and Ed Markey could only muster a seven-vote margin for legislation promising clean and secure energy and a solution to global warming suggests that there must be some devilish details in its 1,300 pages. Devilish, indeed, this bill could well sink a big chunk of America’s economy into economic purgatory for some time to come.

The journey of HR 2454 began over two decades ago with the United Nations’ creation in 1988 of the Intergovernmental Panel on Climate Change. IPCC’s mission statement is straightforward: “The role of the IPCC is to assess on a comprehensive, objective, open and transparent basis the scientific, technical and socio-economic information relevant to understanding the scientific basis of risk of human-induced climate change, its potential and options for adaptation and mitigation.”

Skeptics point out the inherent bias of a government-funded mission to identify human-induced climate change. If you don’t find it, does your funding go away?

Twenty years later the IPCC has issued four assessment reports, accompanied by the more important Summary for Policymakers. Each report served to raise the ante on the alarming dangers of anthropogenic (man-made) global warming, resulting from increased concentrations of greenhouse gases.

At the heart of the IPCC’s work are computer models used to simulate global climate and weather. Any TV weatherman will tell you that predicting next week’s local weather is an iffy proposition even with the latest first-alert-Doppler-whiz-bang-Vipir radars.

The IPCC’s ever-more-confident and apocalyptic warnings rest on the near-impossible task of simulating with computers climate conditions for the whole planet and not for next week but for 50 to 100 years in the future. This, while science still struggles to explain exactly how clouds work.

World-renowned mathematician Freeman Dyson, who in his early years worked alongside Einstein and is now professor of physics at the Institute for Advanced Study at Princeton, had this to say about climate models: “The models solve the equations of fluid dynamics, and they do a very good job of describing the fluid motions of the atmosphere and the oceans. They do a very poor job of describing the clouds, the dust, the chemistry and the biology of fields and farms and forests. They do not begin to describe the real world that we live in.”

Falling in line with IPCC thinking, the primary goal of HR 2454 is significant reduction in carbon dioxide and other greenhouse gases. The proposed methodology to accomplish this is “cap and trade.” It is similar to the program instituted in the 1990s to reduce the threat of acid rain.

In that program, the culprit was sulfur dioxide emissions from 503 coal-burning plants in and around the Northeast. The “cap” refers to the aggregate limit of SO2 emissions to be allowed from the plants in the program.

The “trade” refers to the credits or allowances that each plant requires to match their SO2 output. An investment in technology that reduced SO2 emissions for one plant would allow that plant to sell its allowances to another plant.

The arrangement provides flexibility and market incentives in lowering the aggregate SO2 emissions. The program succeeded in reducing those SO2 emissions by 40 percent. Whether a successful program focused on 503 plants can scale up to one targeting tens of thousands of plants, and tens of millions of exhaust pipes is yet to proven.

The U.S. is four years behind Europe in implementing a CO2 cap and trade program and based on the European experience that may be a very good thing. Started with great fanfare in 2004, the European program to date has not reduced CO2 but has been a windfall for Europe’s utilities and other smokestack industries.

After heavy industry lobbying, the European Union scrapped plans to sell permits and instead gave them out for free. But that didn’t stop utilities across Europe from raising rates they charged to reflect the “putative costs” of those credits.

Europe’s biggest CO2 emitter, RWE, has come under fire for raising rates while also receiving $6.5 billion in carbon credits for free. Bjorn Lomborg, author of Cool It: The Skeptical Environmentalist’s Guide to Global Warming, points out that the biggest U.S. electric utilities spent over $51 million on lobbyists over the past six months. They have watched the European system unfold and they no doubt want their credits for free, too.

If some form of cap and trade becomes law, the carbon credits (a carbon credit represents one metric ton of CO2 emissions) will be on its way as a new form of global currency with a wide array of regulators and issuers and, no doubt, any number of unintended consequences.

Entrepreneurial types have been planning for this possibility for some time. The Chicago Climate Exchange has been trading carbon credits since 2003 and has over 400 corporate partners.

One of the earliest planners was the now-deceased Ken Lay of Enron fame. He got some new notoriety for a 1997 internal memo that said: “If implemented (the Kyoto Protocol) will do more to promote Enron’s business than almost any other regulatory business.”

As we dig our way out of the rubble and wreckage of last year’s financial crisis, the visage of a confident Ken Lay is not comforting. Even more disturbing is the common thread linking the best and brightest of the recently busted and bailed-out Wall Street and the best and brightest of the IPCC.

The thread is computer models seeking to simulate extraordinarily complex systems. Wall Street’s most prestigious firms watched firsthand in 1998 as the premier hedge fund, Long Term Capital, with the guidance of two Nobel Laureates, collapsed, a victim of computer simulations that failed to capture the real world. Did Wall Street lose faith in computer simulations? Far from it – within 10 years Wall Street had magnified the simulation fiasco a hundred-fold.

The Heartland Institute’s exhaustive analysis of the IPCC’s most recent report entitled “Climate Change Reconsidered” includes this critique: “Scientists working in fields characterized by complexity and uncertainty are apt to confuse the output of models – which are nothing more than a statement of how the modeler believes a part of the world works – with real-world trends and forecasts. Computer climate modelers fall into this trap, and they have been criticized for failing to notice that their models fail to replicate real world phenomena.”

Some final considerations: The climate glass may be half full. CO2 is not a pollutant in the way that we normally think of pollution.

In fact, CO2 is vital to our ecosystem and as we learned in 10th-grade Biology, CO2 is a crucial part of the photosynthesis process that turns sunlight into carbohydrates.

Even with the increase over the past 50 years CO2 still only makes up .4 percent of the atmosphere and the increase actually improves the planets potential for plant growth as greenhouses are want to do. Water vapor has a much bigger greenhouse effect but it is excluded from the models because like clouds, it is too hard to model.

Improved plant growth will make it easier to feed the planet’s 6 billion residents. Contrary to IPCC predictions, the Earth’s temperatures have been dropping since 1998.

In fact, this June was the coolest June in New York City in half a century – let those UN bureaucrats out of their cubicles and into the real world of Central Park. Many scientists think temperature swings have more to do with solar flares and sunspots than with CO2 concentrations.

Lastly: Government funding, political agendas and computer models make for a dangerous concoction; just ask Fannie Mae and Freddie Mac.

Mother Nature can take care of herself and so can the rest of us.

July 7, 2009

Vector Money Management, Inc – Second Half 2009 Outlook

Filed under: Market Comments — admin @ 4:23 pm

September 21, 2008

COMMENTARY — Historic Wall Street woes: Building back from bust

Filed under: Market Comments,Newspaper Articles — admin @ 4:24 pm

This commentary appreared in the Clarion Ledger on 21 Sep. 2008
September 21, 2008

COMMENTARY — Historic Wall Street woes: Building back from bust

Three of nation’s top five investment banks collapsed with two more in merger talks

Ashby M. Foote III
Special to The Clarion-Ledger

Watching the conflagration that is consuming Wall Street one is reminded of the famous words of New York baseball manager and philosopher, Casey Stengel: “Can anybody here play this game?”

Casey was describing his 1962 Mets team, arguably the worst baseball team in major league history, but compared to today’s Wall Street investment banks the 1962 Mets look like all-stars. 2008 began with five top tier investment banks and less than 10 months later only two are left standing on their own with one of those in merger discussions.

Bear Stearns collapsed in March and was sold for pennies on the dollar to J.P. Morgan. On Sept. 14, Lehman Brothers declared bankruptcy and that same day Merrill Lynch, under duress, accepted a buyout offer from Bank of America for half of its Jan. 1 value.

The two remaining investment banks, Goldman Sachs and Morgan Stanley, have lost 44 percent and 56 percent of their market value respectively.

Add to that carnage the demise of the insurance giant AIG and mortgage titans Fannie Mae and Freddie Mac and you have the biggest bank panic that anyone can remember.

Investment banks have taken the biggest fall in this financial panic but there is plenty of blame and pain to spread around. In short, there has been a systemic breakdown in the fiduciary checks and balances that govern the relationships from borrowers to mortgage brokers to appraisers to underwriters to securitizers to rating agencies to bond insurers to investors.

At the nub of this crisis is a glut in residential real estate and what is now a two-year decline in home prices. The Case-Shiller U.S. home price index peaked in the Spring of 2006 and has declined 18 percent since then.

In the early 1980s a hot political issue was the plight of the homeless. Twenty-five years later, America is the best-housed and, unfortunately, the most over-housed country in the world. Don’t let it be said that capitalism can’t deliver the goods.

Alas, grand production untethered from prudence and market disciplines can result in gross oversupply and the busts that inevitably follow.

What makes this bust so insidious and seemingly intractable is the large role residential real estate plays as collateral for trillions of dollars of complex pools of debt in bank, insurance and pension portfolios. This is how a housing bust has become a credit calamity.

The genesis of this over-build of residential real estate can be traced back to 2003-2004 when the Federal Reserve, fearing deflation, dropped its key interest rate, the Federal Funds Rate, to 1 percent and kept it there for a year.

Ben Bernanke had presaged this move with a November 2002 speech entitled, Deflation: Making Sure “It” Doesn’t Happen Here.

With stocks still suffering from post bear market blues and bonds offering paltry returns, super cheap money gushed into the asset class that was performing best and seemed the most reliable – real estate, especially residential real estate.

This gusher of investment into tangible assets was further supercharged by new levels of clever financial engineering in the form of complex pools of securities with acronyms like CDOs (collateralized debt obligations) and SIVs (structured investment vehicles).

No discussion of today’s panic would be complete without mention of the credit rating agencies Standard & Poor’s, Moody’s and Fitch and the complicit role they have played.

These are public companies compensated by the underwriters to provide ratings on securities being issued but because of rules governing bank and insurance portfolios the rating companies become de-facto regulators.

When the market for CDOs and SIVs took off in 2004 and 2005 the rating agencies gave investment-grade ratings to most of these new structures that included large chunks of junk debt and sub-prime loans.

With yields 4 to 5 percent higher than similar rated corporate bonds, sales of CDOs mushroomed to $500 billion by 2006.

By the end of 2006, CDOs had become the most profitable and fastest-growing portion of the rating agencies business.

The symbiotic relationship between underwriters and rating agencies is an unhealthy one and a major contributor to the proliferation of CDOs in institutional portfolios worldwide. It is fair to say that we are witnessing in real time the end of an era. Investment banks and their bankers have been the castles and crown princes of Wall Street. Need advice for corporate strategy, mergers and acquisitions or how to invest a billion?

It was to investment banks that big companies and big investors turned. Investment bankers have had their detractors as well – portrayed in movies like Wall Street and books like Bonfire of the Vanities as masters of the universe, the egotistical key-masters and gatekeepers to the really big money of capitalism.

As events and companies have unfolded and unraveled over the past eight months it has become clear that investment banks have been pushed to reinvent their business models over the past five years. For some it worked, but mostly it didn’t.

Information technologies and especially the Internet have flattened the investment arena, squeezing profits in some areas and allowing hedge funds, private equity and boutique research firms to compete in areas investment banks once dominated.

In a classic response to such disruptive innovation, the investment banks moved up market to more complex products where better profit margins could still be maintained. In retrospect it is clear now that in many cases they were pursuing complexity for complexities sake rather than for improvement in their product or service offering. In so doing they violated the old G.I. axiom “keep it simple, stupid,” and they have paid the consequences. Lastly is leverage. Lehman Brothers and Bear Stearns succumbed to the same fatal flaw: making outsized bets with outsized debt.

Both firms morphed into huge hedge funds, at times utilizing 30- to-1 ratios of debt to equity in an effort to juice returns. Markets and leverage mixed with hubris makes for a powerful concoction. But get the recipe wrong and it can wipe you out. Stengel had counsel for such folly: “Been in this game 100 years, but I see new ways to lose ‘em I never knew existed before.”

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