Monday, August 29, 2011

Warren Buffett is Smarter than You are; No, Really, He is

Last week somewhere between an earthquake and a hurricane, Bank of America (BAC) seemed like a stock headed to zero, especially to those of us who have previously, namely 2008, witnessed such behavior in bank stocks. Last Monday BAC shares had been hit with a crescendo of selling owing to a number of factors, not the least of which was a blog post claiming that BAC was roughly $200 billion under-capitalized. The implication was, so the rumor flew, that BAC would, if not go under completely, dilute shareholders to oblivion with a capital raise many times larger than the bank's recapitalization during the last banking crisis, from which, of course, we have yet to recover. Investors exited from the shares, and the short-sellers flowed in, borrowing shares of BAC just for the purpose of selling them and selling them and selling them. Then Wednesday morning, so the story goes, Warren Buffett emerged from the bathtub with an idea to invest in BAC, placed a call to BAC's CEO Brian Moynihan, and, bingo!, a mere twenty-four hours later, the greatest investor of all time owned $5 billion of preferred shares of BAC stock sporting a 6% annual dividend yield.

BAC shares jumped on Buffett's purchase but may revisit lows.

Warren Buffett has played deus ex machina in the past for the markets. As a deep value investor, he invested heavily in General Electric (GE) and Goldman Sachs (GS) during the oh-so-recent unpleasantness of 2008, when short-sellers raided the firms over liquidity and solvency concerns similar to the fears stirred last week about Bank of America. The difference? For both the GE and GS deals, Buffett received a nice, round 10% annual dividend yield, much higher than the still impressive 6% from the BAC deal. That difference shows me that the banks and businesses in general are much better capitalized than they were in 2008; otherwise, Buffett would have been able to demand a higher yield than 6%. Now, don't misunderstand me. As a BAC investor, I'm not thrilled with paying 6%, even to Warren Buffett, for capital that Brian Moynihan has claimed and claimed again that the bank did not need. He was, of course, protesting a bit too much.

The financial media has been split over the deal. Of course, the terms are good for Buffett, but in a nearly no-rate interest environment, 6% is an expensive bill for Bank of America to pay every year for under-needed capital. Of course, the shares rallied considerably in an ugly market Thursday and rallied nicely into the weekend to close the week at about $7.75. Not bad, I'd say, for a company whose shares traded at nearly $6 recently. I think the stock will retest its recent lows, despite how respected Warren Buffett is as an investor. Yes, he is hands down, the greatest stock investor of all time; yes, over his investing career, he turned roughly $200,000 into $45 billion; yes, he has an uncanny ability to recognize value where Wall Street doesn't. Yes, yes, yes, but Warren Buffett is no trader, as he himself will admit, and in both the GE and GS deals he did not call the bottom of the stock. He does not call bottoms. He simply holds onto shares of good companies forever and has more patience than the short-sellers and can outlast any recession or depression or credit crisis. Whereas I hold a (nearly) permanent portfolio, Warren Buffet devotees hold a (truly) permanent portfolio.

What's the plan, then? You could either buy now and hold as long as Buffet, or you could wait for the stock to test the lows and then buy, because, as I mentioned, Buffett doesn't usually buy at the bottom. Even if $6 is the bottom, traders and short-sellers will make sure BAC tests that low at least once more. I first recommended BAC shares on June 21, 2011, at a price of about $10.50. I liked the stock then, and I love it now at about $8.00. I will add to my shares closer to $6.00 and hold them for (almost) as long as Buffett. If the shares make their way down to a 5-handle, I'll double my position. Either way, as I have mentioned in previous articles, without the banks' participation, any substantial recovery in the stock market or the economy is as evanescent as the bubbles in Buffett's bath.

Saturday, August 20, 2011

What Tolstoy Would Say About the Market Plunge

Considering the market action this week, I suppose this is as good a time as any to pull out the Tolstoy quotations. My wife, along with many of my former colleagues, will say with a collective sigh, "Not Tolstoy again." Yes, Tolstoy, one of my favorite novelists, has much to say on all things human and universal, and his first line from Anna Karenina is perfect for what we've been witnessing in the market over the past couple of weeks: All happy families are alike; each unhappy family is unhappy in its own way. What does that have to do with the recent unpleasantness in the market? I say unpleasantness even though it has only been unpleasant to those of us who actually still own stocks and are still bullish, which I guess means about a dozen or so investors in this world of bears. All week I have been hearing market pros in the financial media tell me what the beginning of a bear market looks like; what capitulation (when nearly all investors finally give up and sell all their stocks seemingly at once) looks like; what financial contagion from Europe looks like in the U.S. stock market. I would like to suggest to the experts that, All happy markets are alike; each unhappy market is unhappy in its own way.


No one has ever called the market bottom and then called the top perfectly, despite what you might hear from some trader-turned-teacher peddling his stock market trading secrets in a book or website guaranteed to take the risk out of trading assets like equities. Investing in equities is by its very nature a risky endeavor, so these peddlers, despite their claims, didn't get it right either. Perhaps there once was a trader who timed the bottom perfectly, but I bet the next day he was struck by lightning three times. The point is this: the only way to increase substantially the probability of making money in the stock market is to buy quality companies with solid earning and investor-friendly dividend policies during market dislocations, like the one we're currently suffering, and hold on to them until the panicky traders come back to you and say sheepishly, Um, excuse me, but can I buy those shares back from you that I sold you when I thought the stock market was going to zero? Pretty please? To which plaintive query we will say, No, not until the market is ridiculously overbought. In the long run, if you buy what others are selling, you will make money in stocks, but you must have patience and unflappable nerve.

This week I've heard a whole bunch of people in the financial media arguing over whether we are witnessing the bottom of a correction or the beginning of a new bear market, a fruitless exercise that only worsens the panic in the traders' twitchy fingers as they sell their equities at a steep loss only so that they won't lose more. What is wrong with selling halfway down and buying again at the bottom? It's surely better than losing everything, isn't it? No, don't sell. If you sell now and lose a whole sack of money, you probably won't have the nerve to buy lower, and, as we've already mentioned, you can't time the bottom; furthermore, the market will skyrocket from the bottom, whatever it may be, as it did in March 2008. You'll simply miss it. Those market experts who try to compare the past few weeks to similar time periods of the past will be doomed to the false-positive mistake that we are headed into another recession. I still deem it unlikely with so much, but not too much, money in the U.S. financial system that we will see another recession within the next year; nor is the Euro signaling a financial collapse in Europe, although all U.S. traders seem certain that the Euro will soon cease to exist and that the return of the Deutschmark will signal the fall of Europe. That's unlikely, with the Euro still trading at $1.44.

What should you buy? All the stocks I have suggested over the past few months I like even more now. I bought even more Alcoa (AA) shares last week, and if they turn out to be worthless, I'll use them to wallpaper my basement, but my guess is that in a year, they'll be worth considerably more than they are worth now. If not, I'll buy even more. We want to be well-positioned for the next top, which may not come for a long while, but when the market gets there, we'll be happy to have bought along the many bottoms we have experienced in stocks over many years' unhappy markets.

Friday, August 12, 2011

Is the Sky Falling? No, Just Your Stocks

All over Italy starting in July and extending through August, retailers mark down their wares to clear out the previous year's inventory. All over Italian towns, bright signs announce sales or saldi, discounts of up to 70%. Italians are clever shoppers and wait to shop even more than they normally do during these times of fabulous savings on shoes and lingerie and hats. This year Wall Street has decided to offer some saldi of its own after the great Italian tradition just in time for Ferragosto, the month of vacation that Italians take in August. In truth, most Italians don't actually take a month off, but the tradition is a beautiful one in the abstract. All of the stocks that I have recommended over the past few months are now trading considerably lower than they were when I recommended them, and last week I took advantage of the market chaos and added to positions in Alcoa (AA) and Bank of America (BAC). Are we really going back into a recession after not fully recovering from the last, the proverbial double-dip? Will the European debt crisis really send us back into a global recession?

This DOW chart does look scary, but the low might be in for a while.

My claim is that we are not going back into a recession and that now, while the Wall-Street Chicken Littles are running around trying to get everyone to panic and hide under rocks and the financial media's art departments are preparing graphics to depict financial Armageddon in anticipation of another market collapse---yes, now is a good time to buy. Of course, you must be willing to hold your shares in your (almost) permanent portfolio and continue to add to positions if the market does sink again to or even below levels that we assumed were generational lows in March 2009. Still, I consider the probability to be fairly low that we will have another recession next year, despite European debt fears and despite the frustration that most Americans feel toward all, and I mean all, American politicians. Germany won't allow the Europeans to default, which is good news for the entire world, and the currency market tells us that. I still need about $1.45 to buy one Euro and if the European crisis is truly as bad as Wall Street Chicken Littles want you to believe, the Euro will fall precipitously. Stocks are historically a pretty bad indicator of the future, whereas currencies usually get it right.

Also, although we still are operating on a limited supply of U.S. dollars in the financial system, there probably are still enough to keep the stock market from going down too much more, as opposed to the dearth of dollars we encountered in 2008 when much of the money in circulation went to money heaven. As I've mentioned in previous articles, we are not facing inflation but still must fight against deflation, and the recent market sell off is solid evidence of the lack of U.S. dollars in circulation. If the stock market gets too scary over the coming months, the Fed will step in with a clever way to prop up the markets with a cash injection into the economy, further infuriating the Adam Smith zealots, who secretly pine for the days like those portrayed in the Grapes of Wrath. And eventually government banking regulators, the creators of the financial bottle-neck currently keeping our economy in a coma, will allow the big banks to lend money again.

Right now you should buy stocks that have stable dividends and that generate a whole lot of cash selling their products. One stock that I own whose company fits this description is the consumer products company Unilever (UN), which is currently trading at around $31.50 and which boasts an annual dividend yield of over 4%. So while all those Chicken Littles are fleeing into 10-year U.S. Treasuries, whose annual yield is currently a paltry 2.6%, you can own a global company with global growth potential and a very safe dividend. Unilever has at least 10 brands that you know well (Lipton, Bertolli, Hellmann's) and probably another 20 that you don't. Furthermore, because Unilever is a European company, you get exposure to the European contagion fear without owning a bank.

Unilever's two year chart. There's resistance at $33.50, but the dividend is solid.

If you are adventurous and have a high risk-tolerance, you could buy some industrials like General Electric (GE) or Alcoa (AA), but whatever you do, don't sell your stocks. Wall Street is counting on your selling at the market low so that when someone gives the all-clear signal over an expensive Manhattan lunch in the coming weeks and the Chicken Littles come out of their holes, the Wall Street traders can buy your shares on sale.



Thursday, August 4, 2011

Where Did All the Money Go? To Money Heaven?

Have you noticed recently that, compared to a few years ago, very few people have any money? Of course, the astute reader will say, that’s because we’re coming out of the Great Recession; unemployment is 9%; and Americans no longer have, or are no longer using, that great cash-printing machine called their home-equity loans to buy expensive purses and extravagant dinners and new cars. Furthermore, I have noticed that people, even people with well-paying jobs, seem to have much less money than they did a few years ago. Recently, I have been out with friends who are well-paid professionals in stable jobs, and even they claim not to have any money. What’s happening to their money? Are they burning it at night? Are they saving it? Are they paying down debt? The financial media claims that even high-end consumers are getting crushed by rising inflation owing to an over-accommodative Federal Reserve, which is a fancy way of saying that the Federal Reserve is printing too many dollars. What’s the correct answer? The money went to money heaven.

In general, the U.S. Economy toggles between periods of varying degrees of inflation and deflation. Inflation results when assets go up in value, and deflation is when asset values go down relative to the underlying currency. We just endured an extreme deflationary period, the Great Recession, which resulted from a global financial crisis. Remember that? My claim is that the reason so many Americans have so little money, even those who are still earning it at the same rate as before the financial crisis, is that the economy is still leaning more toward deflation than inflation, despite the Federal Reserve’s attempt to replace the money that went to money heaven. Most think that inflation is bad because the word connotes some of the hyperinflation catastrophes that you might remember from your middle school history classes: governments inflating their way out of debt until their currency is worthless, and then printing ridiculously high denominations of their currency. But a little inflation is necessary to keep an economy afloat; inflation helps your money grow in value, unless you have it parked in U.S. Treasuries or in cash. No, we’re definitely still feeling deflationary pressures. That’s why there’s not enough money around.

There may be enough money in the system now after the Fed’s action during the past few years, but the cash certainly has not made its way to the consumer or even to many businesses. When the money does make its way thoroughly into the monetary system, there will be a re-inflation of the currently deflated economic balloon. That re-inflation is called reflation. I would now like to suggest a stock for your portfolio for the future reflation that must occur after a deflationary period or, indeed, for inflation, when we finally see some growth in the global economy. Baltic Trading (BALT) is a global shipping company that transports dry-bulk around the world by sea using large container ships. BALT currently trades at about $5.50 and recently has seen its share price dip to a 4-handle. This week BALT raised its dividend from 6 cents to 10 cents, which has given the stock some buoyancy in an otherwise sinking market. A few years ago, when China was buying everything that wasn’t nailed down, dry-bulk shippers were making loads of money. Companies like Baltic Trading, the most-followed being Dryships (DRYS), saw their shares skyrocket to near $120 or more and then plummet to single digits after the global financial crisis.

Baltic Trading is only a few years old, so the company missed the last boom-bust cycle. That’s good for us, inasmuch as BALT did not do what almost all other companies do at an economic top: expand. Most of the shipping companies added vessels during the economic expansion. It’s a natural reaction to want to expand your business during good economic times; the only problem with adding container ships is that when demand dries up for shipping goods globally by tanker, there are too many ships, which drives down the rates that shippers like BALT can charge for their vessels. What’s the good news? BALT has virtually no debt and a brand new fleet. When the larger companies start to shed their aging fleet to the scrap yard, Baltic Trading will see its profits rise. Also, when the world economy reflates, dry-balk shipping rates will increase again. Baltic Trading is kind to investors with its dividend. The dividend may fluctuate from quarter to quarter, as may the stock price from day to day, so this investment is not for the timid; nevertheless, over the long term, BALT should do well.

And for those of you who might believe that the current shortage of money in the system is a modern phenomenon, I leave you with the following quotation from I, Claudius by Robert Graves, which was first published in 1934. The passage refers to an event that occurred in 32 A.D, which we just went through again in 2008.


The result was that all debts were at once called in, and this caused a great shortage of current coin. Tiberius’s great idle hoards of gold and silver in the Treasury had been responsible for forcing up the rate of interest in the first place, and now there was a financial panic and land-values fell to nothing. Tiberius was eventually forced to relieve the situation by lending the bankers a million gold pieces of public money, without interest, to pay out to borrowers in exchange for securities in land.