A friend of mine just sent me this article cum press release for a new IBM web platform: http://www.pcworld.com/businesscenter/article/152771/ibm_crafts_web_30_collaboration_tools.html. He commented that it felt to him like a lot of todo over nothing. Here is my response:
This post is just a quick note to comment on some recent trends in the markets. I think at this point, few of us are still trying to call a bottom. If that's really become the case, then we're a step closer in what Barron's Mike Santoli calls the market's "capitulation". That is, investors giving up, getting scared, and moving money to the sidelines.
I guess that's necessary and part of the cycle. However, it's created loads of very low-risk deals. You can find any number of stocks with dividend yields now well above those of corporate bonds. That means that you're getting an almost guaranteed rate of return on equity that's higher than the almost guaranteed rate of return on bonds, which are a safer investment due to their placement in the capital structure. This return is not without its risks, of course, as the dividend relies on good earnings and the board of directors not deciding to cut it. However, I think there are plenty of stocks for which it is the case.
Most importantly, to most people who would argue with me, the question is not of calling a bottom, but rather, as Warren Buffet pointed out in his recent op-ed in the NY Times, of deciding at what price you're willing to own the stocks. Some good deals may go away, others will not. I'm in it for the long haul, so I'm happy to jump on a good deal when I see it. If it drops 10% in the near term, so what? Maybe I'll buy some more to average down on my cost basis. However, I'm confident, along with Buffet, that in 10 years time these stocks will be worth more than their weight in gold, and I'll have been paid handsomely to hold them the whole time.
There's been an absolutely profound breakdown in the mortgage lending process. I would contend that the "subprime crisis" is misnamed, as it's really the "no-doc crisis" that's been the root of the problem. No-doc loans are predicated on the idea that credit scores are sufficient to establish credit worthiness, and we have significant data establishing historical default rates for various credit categories. For example, 56% of loan recipients with <600 FICO scores defaulting on their auto loans within two years (data as of 2005, Standard & Poors), you have to wonder why lenders would finance anyone in that category, let alone at only an 11% interest rate.
This article presents a very interesting alternative view: http://www.basis.wisc.edu/live/amabrief07-09.pdf. Loans to all borrowers have the potential to help them. However, banks need to realistically price that assistance. If 56% default within two years, then a 28% coupon will just break even (not including inflation & assuming all loans are the same size). In fact, banks might actually start high and DROP the interest rates over time as borrowers prove they can keep up with the payments, which might provide better incentives to continue payments and reduce the "moral hazard" problems of borrowers who do not actually intend to pay the loans.
The show 60 Minutes presents another side of the story: http://www.cbsnews.com/stories/2008/01/25/60minutes/main3752515.shtml. The fact that people don't want to pay simply because the "price or the value [of their house] is going down" is reprehensible. Boston's tax assessor's database lets me pull annual historical housing values for the last 20 years on any property in the city. A quick look at properties in my neighborhood shows that from 1991-2000 house prices were "underwater": http://www.cityofboston.gov/assessing/search/default.asp?mode=value&pid=2203905000 (I have no affiliation with this property, I just used it as an example because it's currently on the market - for above the assessed price!). That's happening again now in parts of the country, especially in historically weak markets like Stockton and Phoenix (the Dorchester neighborhood of Boston, too). In fact, in 2007 the number of foreclosures in just Stockton, CA (~2,400) was higher than all of the foreclosures in the Commonwealth of Massachusetts (~2,100).
The worst is yet to come and despite the federal stimulus package and other reforms, we will not see the bottom for 3-4 years. That's based on a rough look at historical housing prices from the Boston assessor's database. I'll also note that house prices moved independent of the dot-com boom in the late '90s, which might have caused values in some places (SF Bay Area, for one) to turn up, but certainly wasn't a rising tide. It was only after the dot-com bubble that things really started to get going in housing.
My advice: stay short anything to do with housing. Yes, Blackstone is starting to get long mortgage lenders. They have the luxury of a long time horizon, deal & management fees, and aggressive recap methods to which individual investors do not have access. Think twice about buying a home unless you're planning to hang onto it for more than 10 years. The Boston bottom didn't occur until 1994-1995, and at it's bottom prices were 28-33% below the peak. The $50,000-$100,000 in lost value is far more than 2-years' rent, so you'd do well to wait out this plunge.
Finally, ride the commodities tide. I believe that commodities are the next asset class to be inflated (after stocks, then housing). We started to see the rise, mostly in oil, beginning in 2005 and 2006, and I think it will continue as housing loses its luster. Gold will definitely hit $1,000 this year - probably in the first half - and other commodities will continue to rise as well. It helps that more people throughout the world can afford them, but it's chiefly because people pile into markets one after another. When your taxi driver or favorite celebrity says to invest in commodities, it'll be time to sell.
Hey Folks,
Just a quick post this morning. Most people watching the markets this morning are probably frantically pushing the sell button. I'm just popping on the record today to say, take your hand off the sell and start thinking about holding it over the buy button.
I don't think we'll see the markets turn up immediately, but we've displaced more than just the speculative inflation that follows most common stocks (a la Ben Graham). People are freaked and your best short-term investment is probably the VIX (options volatility index). I'd also suggest snapping up some longterm corporate bonds - anything with a spread of >5% from US Treasuries or LIBOR. Global inflation's going to be a bit higher in the future, but it's unlikely it will rival the ~10% coupons that some stable corporations are offering right now.
We're on the precipice of a crash, so avoid irrational moves and wait 'til after to take major stakes. At the latest (least risk), we'll see Congress step in with new legislation - likely after the new President takes office next Jan. - to clean things up (eg. CDOs, CLOs, and SIVs) and make sure it never happens again (yeah, right...) Just as Sarb-Ox tried to spit-shine corporate accounting in '02.
Them's the news. So for now, ride the crash down (or step aside and let it crash), then look to ride the rally back up!
Happy (deal) hunting!
-A
Scalability is the question that plagues everything in business. Do the operations scale? Do the systems scale? Does the organizational structure scale? Better phrased: What does it take to scale this business?
Scale is often cited as a major determining factor in the output of various business models. Consulting, law, and accounting are examples of businesses that scale as a factor of people. As in, the company's production is directly governed by the number of employees. Since the only physical products of these industries are documents, it's fair to say that output is entirely contingent on people. Therefore, to produce more you must hire more people, which is difficult and expensive.
Contrast that with Google, the epitomy of hosted services. The company essentially provides hosted software, which is monetized through ads. It employs roughly 10,000 people, mostly developers, and serves hundreds of millions of users. That's a massive scale, although they have their own problems based on maintaining sufficient revenue per user.
Here's one way to think about scale:
Say you have a web company, XYZ.com. XYZ.com earns $1 per user per month and has 100,000 regular users. That means they're making $1.2 million per year. That's enough to support a staff of 15 at an average salary of $80,000 (assuming no other costs), or really a staff of 12 at that salary with $240,000 in annual web hosting costs.
What's the incremental cost of scaling to support 1,000,000 users? You'll have to add a couple more servers at your hosting facility, say doubling the cost to $480,000. Will you need to add more employees?
Possibly, but you won't really need more programmers, and if you run a service like Google's, you won't need more customer support staff because there's almost no tech support. Therefore, your hosted solution virtually eliminates your scaling costs. Incredible, isn't it?
I just read a very interesting article, "Tech Start-Ups Have Money to Burn, but Choose Thrift", published last week in the Wall Street Journal. It discussed the recent trend of venture capital-funded companies to focus on keeping costs low, as opposed to the Dot-Com era practice of spending large quantities of cash on over-sized staffs and flashy marketing campaigns.
This change highlights the maturation of the tech start-up industry. This industry really had its genesis only 30-40 years ago. The professionalism with which companies are started today compared even with the start of Apple Computer and Microsoft in the late 1970s is incredible - those companies did not really even incorporate until years after they began, nor did they receive venture financing until they were in a late-stage and already cashflow positive.
It wasn't until the Dot-Coms that the start-up industry became prevalent enough to attract the critical mass of participants required to create a problem - and through that problem, the learning necessary to create a mature, stable industry. Ideas on how to finance and run tech start-ups had to be tested and proven or disproven. Unfortunately, this trial-and-error method - the only true way to solve a new problem (at MIT we were taught that often you can't theoretically solve a new problem until you're hacked your way through to a solution at least once) - cost an awful lot of money. However, it also created the rapid buildout and growth necessary to create a generation of seasoned entrepreneurs and investors that can provide mature, moderate-paced growth over the next 20 to 40 years.
One of the primary understandings that came from the Dot-Coms is that financial discipline (aka cleanliness) is next to godliness. Today, investment in venture capital firms is near an all-time high. Tier 1 firms like Kleiner Perkins and Sierra Capital are managing well upwards of two billion dollars, whereas just ten or fifteen years ago they were managing funds on the order of two hundred million dollars. That means that their average deal-size has to go up almost ten fold to provide the same performance returns as they did previously.
Therefore, there are a couple ways to solve this problem:
Some firms have, in fact, invested in more mature companies in order to "flip" them by selling them to bigger companies within 1-2 years of financing. However, this investment strategy produces lower returns, requires more deals because most VC funds are designed to run for ten years, and underutilizes the skillsets possessed by VC firms (ie. professional management advice, great rolodexes for hiring senior executives). While this approach was one of the most popular solutions in 2004 and 2005, the reduction in start-up M&A activity over 2006 suggests that VCs have already moved away from it.
Overvaluation or diluting entrepreneurs' shares lasted for far less time than the late-stage investment strategy. Such an approach just doesn't work mathematically - it kills later rounds of financing because the market wises up, or demotivates the entrepreneurs since they no longer have enough skin in the game equity-wise for it to be worth their full efforts.
Biotech and nanotech enterprises do take more time, but that also makes them somewhat impractical as start-ups. In the end they sort of fit the same VC investment approach as the silicon industry - a high capital expense (CAPEX) industry due to the cost of manufacturing machines and laboratory R&D. There tend to be fewer successful start-ups in this space, and many do their work mostly on computers where R&D is significantly less expensive. The development cycle makes it difficult for VCs to extract a liquidity event in the 5-10 year time horizon they need to make their results.
That leaves over-diluting a company and installing strict fiscal discipline practices in order to extend the duration between fundraising rounds. What this strategy amounts to is giving the start-up a war chest with which to protect itself from the unforeseen and maybe make strategic acquisitions where possible. This improves the overall stability of such start-ups and doesn't result in the long-term dilution of entrepreneurs shares because it's roughly equivalent to getting two rounds of financing at once.
In addition, the improved stability of the start-ups improves their overall chances for success, which changes the risk profile for the VCs. By pursuing this strategy they can reduce their risk while keeping returns and their deal-rate steady, as well as capitalize on their unique competency in start-up management.
While we have yet to see how this new funding strategy will play out over the long-term, first impressions suggest that it is a mature strategy that possesses the insight of seasoned professionals who have learned from their past mistakes in the Dot-Com era. Hopefully, we will see this model continue to play out for the foreseeable future as companies continue to make use of the new economies-of-scale afforded by Web 2.0. At the same time, this maturation suggests that we will not see another truly disruptive technology enter the marketplace for quite a while, as the current industry is becoming so mature.
After a volatile month, it seems that everything's cooled down both in the oil sector and in the Middle East (aka, the oil sector), and Wall Street's psyched. But hang on to your hats, boys and girls, because the rollercoaster ride is not over yet. In fact, it's just starting.
Let's look at why our market fundamentals are indicating that this trend in volatility and increased oil prices isn't going away any time soon.
That's quite a laundry-list of items there... so, you might ask, what does it all mean? Simply put: a high risk of stagflation! But Ash, didn't we kick that back before you were born when Reagan and Volker threw out Keynesian economics?
NO!!! We've been falling back into New Keynesian economics since the early '90s. It seems that the allure of the "tools" offered by Keynesian economics, like the IS-LM model, were too much for economists to pass up, so they "reconciled" them with the monetarism that has proven so right in the last 25 years. No wonder I dropped Macroeconomics...
New Keynesianism is just as wrong as Keynesianism was in the last century. It proves great for a while - the Go-Go 60s or late 90s - but it doesn't last, and we're about to see that again. Mid-East violence is resurgent, and the world's oil supply is stretched more thinly than it was in the 70s thanks to added consumption, not only in the U.S., but in Eastern Europe, India, and (the 800-pound Panda) China. That means that smaller shocks have bigger ramifications in the world market.
Those shocks have been exacerbated by the entry of large quantities of hedge fund and private equity capital in these markets. Thanks to a loose fiscal policy and too much money in the market, this extra capital has driven prices up beyond anything that OPEC or anyone else can control. And despite what most of Wall Street currently believes, this capital is not a result of unparalleled prosperity... IT'S A RESULT OF POOR FISCAL DISCIPLINE!!!
That's a harbinger of inflation... in point of fact, it's the textbook definition of it: Too much money chasing too few goods. The markets just haven't put two and two together yet. Why? Simply put, inflation is the hardest thing to get right. People don't believe predictions about shifts in inflation until they perceive shifts in inflation (thanks Dad for that epiphany!). That means that they don't expect it until too late.
So why am I so bearish if I'm not suppose to be believing in inflation yet? Simple: I don't have a lot of money, and I remember just 6 years ago when gas in San Francisco, California - the most expensive region for gas in the country - was only $1.75. I don't think you can tell me that the price of gasoline doubling in only 6 years is not going to create added inflationary pressure in the economy, especially not when the price of crude oil has not just doubled but tripled in that time.
What this means for the economy is a lot of pain. We haven't been taking our medicine, we've been driving big cars, running up astronomical debt on our houses (according to The Economist, the housing bubble, as a percent of GDP, is half-again the size of the dot-com bubble), and purchasing everything in sight... all while that nasty cancer has been growing under the surface.
It's okay... that's just human nature. However, it's coming time for the Chemo to start. We might lose our hair for a while, maybe we'll pull it out, maybe it'll fall off, but it'll grow back eventually. The question is now not if, but how long? And that, my friends, nobody knows.
Recently, my father sent me a Wall Street Journal article that I had been staunchly avoiding. Feeling bad about deleting it outright, I briefly skimmed it before sending him a verbose reply explaining my rational for avoiding the piece. In fact, my actions are likely to shock both my father and many of my friends. I am an avid Journal reader and consume about as much information about personal finance as I possibly can. Why then would I refuse to read a Journal article about personal finance?
The answer is simple: BECAUSE IT'S SO WRONG!
That's right. Even the Journal's authors can be quite wrong when it comes to topics that they know little about. They just fall into the same trap that most other media outlets fall into... annointing their columnists as so-called "experts" when they really have no business talking about that subject.
Take, for example, this author's comment that one should not begin "seriously saving for retirement" until after age 30. They couldn't be more wrong. Analysis has shown that someone who puts away a fixed amount every year from 20 to 30 and stops will have almost twice as much in the bank at 65 than someone who puts away the same fixed amount from 30 until 65. That's the power of compound interest!
Good financial advice will tell you that. In fact, it's one of many questions I use to triage whether or not somebody knows they're stuff about finance.
Here's another question: when are student loans good? The answer is two-fold: 1) when you need them to finish school, and 2) when you can make a rate of return from investment that is significantly higher than your interest payments. Student loans are somewhat unique because they tend to have more generous terms than most other loans, including lower interest rates. That in turn makes it possible to use money from student loans for investments in securities, which enables you to reap the difference between the two rates (rate of return and interest rate). The caveat: don't try this unless you know how to invest... you're taking on extra risk so you need to be confident that you're not going to actually lose the money (although, better to do it in your 20s than when you have a family to care for).
The first thing that you need to ask when you're getting financial advice, is whose advice are you getting? In other words, why is this person qualified to give you advice?
Let's break it down: what types of professionals are qualified to offer advice? Bankers? Financial Advisors? Columnists? Economists? Successful Businesspeople? Successful Investors?
The correct answer is only the last two - successful businesspeople and successful investors. People like Robert Kiyosaki and Warren Buffet, who have whethered all sorts of financial changes and crises, and made hundreds of millions or even billions over decades. If you're not willing to go that course, than financial advisors may be right for you... they know what they're doing in terms of savings and helping you meet modest goals. They won't generate millionaire returns, but they'll give your kids a college education and you a comfortable retirement.
So if you're keen to start getting advice from the right people, or at least test the water, what should you do? First, take the advice of one of my best friend's fathers, a man whose made many millions in his lifetime, run down to your local bookstore, and buy yourself a copy of Rich Dad, Poor Dad by Robert Kiyosaki.
Now, I've noticed a lot of people have read this book without really reading it. So, what I want you to do is read it once kind of quickly. Then, pull out a pen, pencil, or highlighter and read it again slowly, chapter by chapter. Highlight or underline key points and make notes in the margins. Never read more than a chapter in a day, and if you want extra credit keep notes on a notepad. Get a couple of your friends who share your interest to do this with you and discuss it regularly. This method of studying will help you internalize those lessons.
When you're done, go out and buy another book from a real expert and start scouring the Internet for articles from real experts. They're out there. Robert Kiyosaki writes a column for Yahoo!Finance, Warren Buffet has produced a number of books, some successful mutual fund directors, like the Hussman Funds, regularly publish columns about investing on their websites.
The information's there. GO GET IT!!! And remember to always ask yourself: is this person really qualified to give me advice?
As congress departs for its summer recess, one of the most prominent bills left on the table is the permanent change to the "estate tax". Why is this such a contentious bill, and, more importantly, why are Republicans so wrong on this one?
Estate tax has evolved greatly since its inception in 1916. However, right now it still retains its initial purpose: reducing the income divide between America's younger generations to prevent the emergence of entrenched socioeconomic classes that Europe has been plagued with for millenia. To this end, the tax has been reasonably effective: America has the highest rate of transitions between socioeconomic classes of all developed nations.
On the other hand, as we have seen with the Rockefellers, Carnegies, Kennedys, Bushs, and the like, there is a growing entrenchment of an American upper class. The Republicans current efforts to reduce and repeal the estate tax serve simply to increase this entrenchment - not to help the economy or any other purpose (look at Europe's stagnation!)
What's the difference? By taxing estates valued at over one million dollars (fluctuating wildly over the next five years), we reduce the amount of money that upper middle and upper classes can inherit without negatively impacting the transfer of monies between generations of the lower, lower middle, and middle classes - as in, protecting the American Dream. That means that we promote a meritocracy because each generation has to work anew to reach high socioeconomic stratum.
That's not to say that those children whose parents are already in high socioeconomic stratum will be even with those whose parents are not. Quite the contrary, they have access to the education and networks critical to rapid success. However, what it does mean is that these children must still work extremely hard to enjoy the same success as their parents because they are thrown into competition with more of their peers from other socioeconomic backgrounds. This competition is particularly evident in schools - the profusion of scholarships in elite private high schools and universities, as well as the judicious use of standardized tests and the notorious "tell us how poor and disadvantaged you are" essay questions means that the students accepted to these institutions are rated on their merit as well as their parents' wealth.
What do merit and competition mean for society? EVERYTHING! Economies grow through competition, hard work, and the pursuit of riches. While everyone laments the overinvestment in dot-com companies, the fallout is not as bad as everyone believes - in less than a decade, more well more than a decade's research and development was achieved and the productivity gains resulting from it will continue to propel the global economy for decades.
The evidence is all around us. The 40 hour work week exists only for a very small portion of the population. For example, I'm penning this essay on Sunday. With many companies establishing offices across the globe, it is not uncommon for people to come into the office at odd hours of the morning or night to participate in teleconferences. Work on most projects runs around the clock as offices pass off projects to each other based on their timezones. The proliferation of modern communications tools means that people bring their work home, and continue it on the road as well.
This means that Americans must work both harder and smarter in order to maintain our preeminence in the global workplace. In the face of more competition abroad, we must also make efforts to step up competition at home. Thomas Jefferson is famous for saying "The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants." The truth of this saying has never faltered. However, another, parallel, statement has emerged to be just as truthful: The tree of economic growth must be refreshed from time to time with the blood of the meritorious and the wealthy.
So what's the fallout from all of this? Well, as part of a broader effort this alteration to the tax code risks killing something all (or almost all) Americans believe in: The American Dream.
There is no doubt in my mind that we're entering a new energy market, and that our experience in the last oil shock in the 1970s does not apply to the new rise in energy prices. This fact stems from the rapidly increasing demand in places like India and China - a demand that oil production cannot hope to meet with current energy prices - that did not exist in the 1970s. This knowledge has led a lot of people, particularly investors, to seek opportunities in renewable energy technologies. However, most of these are doomed to failure for the same reasons they were the first time, and - as noted by my friend Kurt Keville - it is important to realize that most of the old players from the 1970s renewable energy field have decided to pass on this opportunity. If nothing else, that should tell you something.
Ethanol is the darling-child of renewable energy buffs everywhere. However, it has a long way to go before it will ever be a serious force in the marketplace. Here are some reasons why:
These seven reasons are just some of the top ones for why ethanol is a non-starter. However, other darling-children of the renewable energy crowd are also doomed to a supporting role. Solar power, which relies heavily on metals and silicon for the production of solar panels (not to mention, extremely toxic chemicals), has too low a power density to replace lots of energy generation systems. Also, throw in the fact that you have to extract the silicon and metals needed for its production from mines, which requires petroleum.
Likewise, wind power has a limited role, since the average windspeeds required for consistent power production make only a small percentage of available land well-suited to wind production. Used in concert, all of these technologies will help ease the stress on current energy supplies; however, they're not going to solve the issue. Ever.
So where does the path lie? Well, in the short term it's simple: conservation. There is incredible inefficiency everywhere in the world, borne of oversupply of power for so many years. That means that we can reap a lot of value out of getting better at keeping what we have.
What else? This is going to make me pretty unpopular: nuclear. There are new nuclear technologies, pioneered in part by my alma mater, MIT, that are completely safe and very efficient. Such technologies offer the energy densities necessary for practical use in a macroscopic application. I predict that China, and maybe India, will be front-runners in exploring the use of new nuclear technologies... Why? Simply because they need it for growth, and they have to be more pragmatic about their situation than the populations of developed nations.
I also predict that the new oil - the new driver of our economy - is something we haven't seen yet, or have relegated to the back of our minds. It's obvious with just a few BOTEs that current renewable energy technologies are not going to meet our energy needs, so it's time for savvy investors to look farther out into the fog to see what's really going to save the day.
