Banks Did It, in the Dining Room, with the Rope

The Jan 2009 issue of The Commonwealth has a fascinating speech by Dick Kovacevich, Chairman of Wells Fargo (WFC). Most interesting is how quickly the banking sector grew.

Wells Fargo started as a business in 1852, and Norwest, where I worked before merging with Wells Fargo, started in 1873. By 1950, our combined assets were less than $3 billion...By 1985, both companies together were still only about $50 billion. Today, they are $610 billion. When our merger with Wachovia is completed, we will be nearly $1.5 trillion. So what happened...that caused this unprecedented growth? ... deregulation, new technologies, non-bank competition, and industry consolidation.

The banking sector is a rarity--despite multiple mergers, competition continues to be fierce. The internet banks, especially ING Direct, keep threatening the big players. Consumers owe (in the abstract) more to ING and other internet bankers than we realize.

The 1980s was a very difficult time for our economy. We had 16 percent inflation, 20 percent interest rates, double-digit unemployment and a severe recession.

Mr. Kovacevich differentiates between an economic crisis and a financial crisis. He says the 1980s was worse than today's crisis, because it was a full-blown economic crisis. Today, however, we have more of a financial crisis than an economic crisis:

We're probably in a recession; we'll be in one until early next year, but we've still got 6.1 percent unemployment, not 14 percent. We have 2 or 3 percent inflation, not 20 percent. We have interest rates at record lows, not at 20 percent...[So] It is a more serious financial crisis...We [the financial sector] really caused this crisis.

His willingness to accept blame should earns points. It's nice to see a Chairman of a major banking company speaking so frankly. He ends with a positive note:

I wouldn't want to bet against all the regulators and all the governments of the world -- this is a coordinated effort. If you want to bet against them, go right ahead, but I wouldn't. They'll get this thing fixed.

Very reassuring words from Wells Fargo's chairman.

Disclosure: I own shares of Wells Fargo (WFC). Warren Buffett's Berkshire Hathaway also holds WFC shares.

Bonus: In the same issue of The Commonwealth, Meg Whitman, former CEO of eBay, talks about California's budget:

Revenues have got to be greater than costs. This is one of the real laws of business. Otherwise, we go bankrupt. We need to change the structural way our budget is being done.

Although I live in California and consider myself a fairly comprehensive reader, I have no idea what's really going on with my state's budget. Last I heard, the Democrats were trying to call taxes "costs" to push through a budget over Republican objections. Come state election time, I may just vote against all the incumbents.

2008 in Review

At the end of each year, I like to re-visit my hits and misses. Let's start with the misses.

My biggest mistake was thinking we didn't need any capitulation (July 25, 2008). The market hit the skids shortly thereafter. At the time I made the call, the S&P 500 was 1,257--now it's 869. That's a loss of around 30%. (Not as bad as Hilary Kramer, but too close for comfort.)

Of course, the market did capitulate later on, and on September 18, 2008, I said it was a good time to slowly re-enter the market. Unfortunately, the S&P 500 was 1206 on September 18, 2008--now it's 869. That's a loss of around 28%.

I also had a near-miss. On July 30, 2008, I praised Garmin when it was selling around $36/share. Fortunately, less than a week later, on August 5, 2008, I sold my shares, writing, "I sold Garmin (GRMN), taking a [small] loss. I violated the rule of never catching a falling knife." Garmin is now around $19/share.

My top hits in 2008?

1. Not only did I predict Longs Drugs would be bought out, I also identified the eventual buyer:

Longs is going to be a good company and attractive takeover target...CVS is going to be knocking one of these days.

I made the call on May 29, 2008. On August 12, 2008, CVS announced it was buying Longs Drugs.

2. On September 19, 2008, I correctly said that Transmeta (TMTA) was trying to conserve cash to become more attractive as a buy-out candidate.

TMTA looks like a company trying to conserve cash to survive. If you're looking for a growth story, this isn't it; however, as long as its patent portfolio remains viable, TMTA may be a potential takeover target or value play at the right price.

On November 17, 2008, Novafora bought Transmeta.

3. I correctly called a short-term bottom in banking stocks and Colonial Bancgroup (CNB) shares. My joyful reaction at making the correct call is here.

4. I called MGM overpriced and told the CEO at MGM's shareholder meeting he was propagating unrealistic expectations:

[Despite your rosy outlook] you're basically telegraphing that you're going to lose money because you're expanding and spending money while entering a recession...

In the same post, I wrote,

Overall, I believe MGM will not be able to replicate its record in 2007 and will make less money in the short term.

At the time, MGM was selling for around $52/share. Now it's at $12.74/share.

If you read the full post, you will see that I disliked the CEO at the time, Terrence Lanni. Mr. Lanni recently resigned after the WSJ reported that he had falsified his resume.

(By the way, the only other CEO who rubbed me the wrong way was Trimble Navigation's (TRMB) Steven W. Berglund. Let's see what happens with him and his company in 2009 and beyond.)

5. Recently, I called the drop in the Canadian dollar overdone. So far, it appears I accurately called the bottom.

6. I called GE a good buy when it was around $14.66 a share. It closed today at $15.66. GE's current dividend yield of 7+% shows it is willing to pay investors to wait until better times.

My favorite "hit," however, had nothing to do with a prediction. At the Yahoo shareholder meeting, I told Chairman Bostock to stop talking about Microsoft, comparing his repeated and unnecessary public proclamations to words from a jilted ex-girlfriend. I also politely suggested Mr. Yang go on a sabbatical. We haven't heard a peep out of Bostock for months now, and Mr. Yang has gracefully exited. Meanwhile, Yahoo stock has quietly made a comeback from around $9/share to around $12/share.

Aside from hits and misses, what was my biggest lament? That this article wasn't more popular among my regular readers. I don't think we're going to see the end of "OCM," so perhaps the article will gain more popularity with time.

As for my thoughts on 2009, I am looking forward to it. I think the S&P 500 will hit 1012 in 2009, but whether it stays there is anyone's guess. Here's the annual Barron's challenge if you're into forecasting.

My riskiest 2009 stock is Maxim (MXIM). I am hoping it will go to $14.90/share by early 2010. I started buying Maxim shares at around $12/share and have been averaging down. Maxim closed today at $10.98/share. If I'm right, my Maxim shares will appreciate 30+% in around one year.

The market's gyrations notwithstanding, it's important to remember that most Americans enjoy one of the highest standards of living in the world. If you disagree, may the new year bring you knowledge and a much-needed passport.

The information on this site is provided for discussion purposes only and does not constitute investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities or make any kind of an investment. You are responsible for your own due diligence.

Indian Newspaper

For those of you looking for non-mainstream news, here's an excellent Indian periodical:

http://www.indianexpress.com/

The North American August 8, 2008 edition had an informative insert called, "61 years of India."

More on Madoff

A consistent 15% return over 25+ years, without any losses, is impossible without some illegal advantage, such as inside information. Thus, Madoff's investors could not have reasonably believed they were receiving 10 to 15% every year without some insider information. In fact, Madoff's position as Nasdaq chairman probably convinced investors they had access to information no one else did. Click on the link for more.

Madoff's investors should have diversified or at least done more due diligence. Their failure to follow the well-known and cardinal rules of investing--diversify and buy only what you understand--is the sine qua non of their current situation.

Also, most of Madoff's investors were not unsophisticated investors--most were educated, English-speaking, and affluent. This is why Madoff slept soundly at night--in his mind, even if someone invested a million dollars with him, s/he most likely had plenty of money left over. Madoff may have even believed himself to be a modern-day Robin Hood--stealing from the rich to give to the poor and the charities.

At the end of the day, the blame belongs on Madoff and the fiduciaries of charities and other entities who failed to diversify donor and investor money. Rather than excuse negligence, Madoff's investors should serve as an example to those who fail to diversify or who do not question impossible returns. Bailing them out would result in the following:

1. It would tell the world America will print money and devalue the dollar when its citizens--especially the rich and well-connected--make avoidable mistakes. If the Japanese, Chinese, Swiss, and British begin to question the U.S. dollar's integrity, it will be the beginning of the end for our entire country. We have major deficits and are currently dependent on foreign investors to finance our expenditures. When we have a surplus, we can afford to be generous. Right now, we can afford to be sympathetic only with our hearts, not with our wallets.

2. It would weaken faith in our country's sense of fairness. Any time a government gives money away arbitrarily, others not part of the largess rightly cry foul. What about all the other victims of investment fraud, like the Baptist Foundation of Arizona or Sunrise Equities Inc.? What about the mortgage brokers who ripped off ordinary Americans by submitting mortgage applications with false income information? (By the way, where's the perp walk for those people?)

To those of you who say I have no sense of compassion or morality, let me say this: if anyone ought to receive taxpayer money, it should be the families of Americans who were slain in Iraq. They are also victims of government inaction and negligence and have lost more than just money. The list of more deserving victims is endless, but if we go down that path, we will transform America into a land of sympathy-seekers, not strength. For a country that has been the symbol of hope for so many people worldwide, such an image shift is unacceptable.

Although I opposed the auto and bank bailouts, they will help hundreds of thousands of ordinary Americans who had little power to avoid their current situation. Auto workers themselves did not cause their current financial mess--the banks, their unions and the Big Three did. In contrast, Madoff's investors failed to do due diligence, failed to diversify, and/or must have believed Madoff had inside information. As a result, they do not have clean hands.

Regulations resulting from the Madoff scandal, if any, should focus on requiring nonprofits and other charities to publicly disclose (preferably on a website) more than just basic financial information. Even in the absence of a law, donors should ask charities and nonprofits to disclose not only their P&L statements and budgets, but also where they are holding donations, and what specific investments they have bought. As long as taxpayer money is not involved, some good may come of this yet.

More on Madoff here:

1. "Capitalism without Failure is like Religion without Sin"

2. The one that started it all: Madoff the SIPC.

3. NY Times mentions Madoff (1/4/09).

Clark Winter's The Either/Or Investor

I originally avoided Clark Winter's The Either/Or Investor because the title is uninspiring and brought back visions of Søren Kierkegaard. I am happy I reconsidered. Clark Winter isn't your ordinary Wall Street denizen. He dedicates his book to his "wife and family," which tells you right away he knows his priorities. You can almost imagine him zipping across the landscape in a Pontiac G8. He seems to admire GM and the car business--which is part of the problem, because he wrote his book before March 2008 and the auto industry's current woes. If you can ignore his sanguine predictions about car companies and auto usage (see page xxxiii, where he praises GM over Ford, and says, "Even rising fuel prices will probably not make much a difference, as American habits are extraordinarily ingrained." [p. 147]), the rest of his book is a joy to read. His comments on immigration are particularly timely, given America's increasing protectionist sentiments:

Despite the belief that immigrants don't contribute much to society besides low-level work, they are in fact instrumental in starting businesses that serve other immigrants. In the United States, individuals start more than 550,000 new businesses a month, according to the Ewing Marion Kauffman Foundation. Latin American immigrants start more business[es] than any other group, following by immigrants in general. [p. 33]

On the whole, immigration is good for investors. It brings new customers, new incentives to innovate, new markets, new competitors, and new capital into the market. The savings rates of immigrants are higher than those of the native born, which adds to capital formation. What immigrants, legal or otherwise, take out of the system in terms of municipal services, they probably make in sales taxes on the goods they purchase. Immigrants start new businesses--and therefore are a greater source of new employment--than their native-born counterparts. Additionally, these new companies add to the capital stock of the community in another way. They bring their talents, hopes, dreams, and skills to countries that are increasingly postindustrial and therefore less inclined to do the jobs that those at the bottom rungs of the economic ladder are willing to take on. All in all, there are few reasons to oppose immigration from an investment perspective, much less a cultural one. [p. 35]

Most investing books have insightful or funny anecdotes and facts, and Mr. Winter's book is no exception. He talks about teaching his son economics while driving to grandma's house [p. 54]; Singapore's rise [p. 66]; the economic concepts of alpha and beta [p. 106]; sentiment's role in the markets [p. 70]; and the role of "expensive beef" in Argentina's rise and fall [p. 73]:

Poverty doubled from 27 percent to 54 percent, and millions of Argentines had their life savings wiped out...During all that time, the diet never changed. If it had, Argentines would have brought down their government. [p. 70]

Mr. Winter's main point is that ordinary investors can invest better simply by paying attention. He calls this "thematic investing," or concentrating on a subject whose outcome might be reasonably predictable [p. 72]. Although he doesn't explicitly say it, he favors momentum trading, because buy-and-hold investors are subject to the vagaries of geopolitical events and other events beyond their control:

You could always be a buy-and-hold investor, but that isn't likely to work, either, as you could lose a lot of money in the process. Markets can and do go to sleep for years, as they wait for geopolitical events to sort themselves out. [p. 72]

Going back to Argentina, if an investor understood or learned how important beef was in Argentina's traditional diet, s/he may have been able to profit. For instance, Mr. Winter's "reality-based" investor could have done well by trading beef/cattle futures, or perhaps by stockpiling beef before the Argentine peso collapsed. However, Mr. Winter supplies his own counterargument when he describes Macao as a good investment opportunity:

If Macao is a good enough investment for Steve Wynn or Sheldon Adelson, two of the most successful investors in Las Vegas real estate, it may be a safe bet for individual investors as well. [p. 77]

Unfortunately, Steve Wynn's Wynn Resorts (WYNN) and Sheldon Adelson's Las Vegas Sands (LVS) have been two of the worst-performing stocks this year. Both invested heavily in Macao. What's the lesson? Even if you know which direction the wind is blowing, it doesn't necessarily mean a beneficial storm will occur at the spot you predict. (Somewhere, John Bogle, an ardent buy-and-hold advocate, is smiling.)

Despite these "oops" moments, I learned a lot from Either/Or. Mr. Winter can explain complex ideas without sounding as if he's speaking down to his readers. On page 94, he explains why companies go public, despite the higher scrutiny (they want liquidity and access to more sources of funding). On pages 95-96, he discusses derivatives (you can almost hear the foreboding music in the background as you read):

[T]he variety of futures contracts available has increased dramatically and the number of contracts has increased exponentially. There are now many more futures contracts in oil traded than actual barrels of oil to be delivered...While futures are supposed to create more orderly markets, sometimes they can add disorder in the marketplace.

I also learned some more interesting facts. For example, Brazil is an oligarchy: "In Brazil, for example, twenty thousand families control 80% of the wealth." [p. 123] Also, the bottom of an oil barrel contains the most valuable liquid:

[W]hen the oil is refined, the lightest components become gasoline and kerosene and jet fuel, which sell for a couple of dollars per gallon. The next heaviest component becomes heating oil, which also sells for a dollar or two a gallon. What is left at the bottom of the barrel is the heavy, tarlike residue that is turned into thousands of different organic chemicals and pharmaceutical compounds...[these can] sell for anywhere from a few dollars a gallon to thousands of dollars a pound.

I'll leave you with Mr. Winter's investing rules:

1. Don't lose money
2. Don't invest where the big investors invest
3. Find a waterfall and put your bucket under it
4. Open your mind

Mr. Winter is obviously a man with both feet planted firmly on the ground. If you're skeptical of buy-and-hold investing, or if you just want to learn more about a different investment style, you may enjoy his book.

Education between the Genders

Greg Mortenson, in The Commonwealth (Jan 2009), tells us a beautiful proverb about education:

If we educate a boy, we educate an individual. But if we can educate a girl, we educate a community.

He is the co-founder of Central Asia Institute, and the co-author of Cups of Tea. In smaller communities, especially poorer ones, Mr. Mortenson is indeed correct.

Ali Salem on Peace

In honor of X-Mas day, I give you some words from Ali Salem, an Egyptian playwright:

Peace will not come to you; you have to make it, you have to sculpt it...you know, business deals lead to peace, not "enlightenment" from writers and intellectuals. [SF Chronicle, 12/19/08, A24]

I have a soft spot in my heart for writers, especially blacklisted ones. Mr. Salem has the right idea--words alone are not enough for peace. Individuals must work together. We forget that racism and lynchings in America were not resolved through American courts, which affirmed both Dred Scott and Plessy v. Ferguson. From everything I've read, when white Americans had to serve with African-Americans in the military, only then did America's racial consciousness change. After all, it's hard to be racist when you spend time with someone and do productive and/or courageous activities together. On this day, I give thanks to human beings everywhere who make it possible for us to connect to other human beings all over the world. Thank you, eBay. Thank you, Doctors Without Borders. Thank you, Google. Thank you, Kiva. And most of all, thank you to the "people who do their jobs, raise their families and sacrifice so that we can gather here in peace."