ESSAYS rod roth

On Investing: Creating an Edge

rodroth — Thu, 17 May 2012 00:35:33 +0000

The fox knows many things, but the hedgehog knows one big thing

—Archilocus

We had one once–a hedgehog. Unprepossessing little guy. Hung out in the box we had for him, made a little grumbling sound at night. Quizzical look on his cute little face. You had to be careful when you took him in hand. He wasn’t aggressive, just had very sharp quills. Gave our dog something to think about whenever she got too nosy.

I never gave the animal a moment’s thought while we had him. Later, reading Jim Collins’ Good to Great, his book detailing the common traits of fifteen companies that rose from being average concerns to outstanding performers, I was fascinated by Collins’ finding that these companies became world beaters through an intense focus on a single product or service which became their entire business.

Over a stretch of time, with much debate, discussion, trial and error, the Good to Great companies narrowed their businesses down to the one thing they were passionate about, that they felt they could do better than anyone else, and that drove their economic engine. Collins termed the trait The Hedgehog Concept, after the mythological singlemindedness of these creatures.

I think that the narrow focus attributed to hedgehogs works well for me as an investor. Here’s how:

Success at investing requires an edge over the uncertainty of outcomes. Hedgehogs don’t control anything other than their own actions. Neither do I. The only certainty is what is right in front of me. My edge, therefore, must be something I can see in the moment. I once heard an advisor tell a group of investors “You get paid to take risk.” I disagree. Warren Buffett, writing about his approach, said, “We try to make the purchase price so good, even a mediocre sale gives a good outcome.” I will devise metrics that allow me to say that the purchase price of my investment gives me better value than cash today, without having to hope for something to happen down the road.

I don’t know what hedgehogs know, but I have some idea about what kind of investing I’m familiar with. A friend once told me he was comfortable with having his portfolio divided between real estate, stocks and gold. I certainly hope that works out for him.

I am familiar with stocks, so that is my singular focus. I buy them when the best companies are cheap enough to provide an exceptional dividend yield. This usually means that they will be worth more down the road, when social mood rises and investors become willing to bid them up. But I don’t want to depend on it because capital growth is the most uncertain component of investment returns, as millions of investors have found over the past decade.

Even a cursory study of the history of markets will tell the investor that stocks have a cycle in which they range from gross undervaluation to extreme overvaluation and back again. When they reach one extreme, they reverse direction and continue in the new direction until they arrive at the opposite valuation extreme. The edge in this knowledge is that I do not want to own stocks from the time they get to overvaluation until they finish the trip to the bottom.

A close study of the Elliott Wave Principle took me out of stocks at the end of 1999. The same studies indicate that the bottom will not come until around 2016, but that is not certain. What is certain is that the bottom will feature massive public liquidation, which will show up in the mutual fund statistics. I last saw this type of event in 1974. It was an unbelievable financial hemorrage.

Today the yield on the blue chip averages ranges from 2.5 to 4%. After the next liquidation, the yields are likely to be north of 20%. My only obstacle then will be my own fear. The blood will probably be running in the streets this time.

Hedgehogs play great defense. That’s what is called for now. Over the next few years, how much we don’t lose is sure to be more important than how much we make.

Cheers,

Rod

The author makes no representation as to the accuracy of the quoted material, but believes the sources to be reliable. No one should consider any part of this presentation as a recommendation to buy or sell any securities whatsoever.

Supersize Demise

rodroth — Wed, 09 May 2012 15:32:34 +0000

NBC’s Brian Williams devotes lots of airtime during the evening news this week to a new medical report that asserts the percentage of obese Americans, presently 34%, will rise to 42% in 2030. My immediate response to the assertion is: Nah, no way. Of course, without any supporting arguments, I can’t even shoot from the hip on this one. But, sticking my gun around the corner of the building, I will fire blindly and flat-out state that the epidemic of pork has peaked.

Has to. Experts don’t take notice of a trend until it’s already long in the tooth. Then, just before it reverses, they forecast it to continue. This trend has been underway for almost thirty years. The parabolic rise has already occurred. Barely seven percent of the population in America was obese in 1985. The most commonly purchased dress size that year was eight. Size fourteen is the biggest(!) seller today, and there are whole departments in clothing stores for 1X, 2X and 3X sizes.

The stunning rise in the number of superfat people tracks the final runup in social mood, which began in the early eighties with the last, most outrageous leg of the Grand Supercycle bull market. Fatness in the population was noticeable, but still a novelty in the early nineties. Japanese tourists visiting Disney World at that time said they were more fascinated with the “balloon people” at the park than with the rides.

In 2003, McDonalds, sensing a marketing opportunity, introduced their Supersize campaign featuring 64 ounce cokes and portions of french fries big enough to feed four Marines coming in off of patrol. The campaign died a couple of years later and, while Sonic and some of the edgier fast food chains are still offering massive burgers to 18-24 year old guys with beastly appetites, the marketing thrust in much of the food business now is towards healthy eating and small plates.

The extraordinary amount of obesity in the culture parallels the mindless self-indulgence of the era. The awesome rise in social mood also gave rise to 20,000 sq. ft. houses, automobiles the size of tanks (Hummers seem to be on the wane around here, but I still see a lot of Chevrolet Subdivisions), and giant toys: At a filling station over the weekend, the dude next to me had a 36 foot sport fishing boat with three 300 horsepower engines hanging on the stern. “What are we talking for a fillup?” I said. “She holds 400 gallons,” he tells me. He’s going offshore to catch the most expensive tuna he’ll ever eat.

The resumption of a Grand Supercycle bear market–starting right about now, methinks–will demolish enthusiasm for expensive stocks, big cars and humongous houses. By the aforementioned year 2030, the siege of balloon people taking up too much space on the planet for their own good is likely to be a distant, fading memory.

Cheers,

Rod

More Misconceptions to Dispell

rodroth — Sun, 29 Apr 2012 18:24:37 +0000

The financial press is full of bull these days.

Walking past the news section in the grocery store, I spot the headline for a cover story in Barrons: OUTLOOK MOSTLY SUNNY!!! Bulls have the edge in the big money pool, predicting stocks will rise 10% this year.

I used to read this comic when they were market savvy. Not anymore. Bob Bleiberg must be rolling in his grave.

Conventional financial analysts can be depended on to forecast the future by giddily extrapolating present conditions in a straight line with total certitude at just about the time the trend is due to change. Elliott Wave analysts extrapolate in fractals, observing that the primary influence in business activity is social mood, which ebbs and flows in fractal patterns rather than linearly. Historically, Wave analysts have made the more reliable calls, and they are calling for a trend change (down) now. This is a good time to ignore conventional financial commentary.

But, not entirely. The April 21st. issue of The Economist features an upbeat section titled Manufacturing and Innovation, containing several articles citing major turnarounds in global competitiveness for American industry. Here’s a short excerpt:

“As manufacturing goes digital, a third great change is now gathering pace. It will allow things to be made economically in much smaller numbers, more flexibly and with a much lower input of labour, thanks to new materials, completely new processes such as 3D printing, easy-to-use robots and new collaborative manufacturing services available online. The wheel is almost coming full circle, turning away from mass manufacturing and towards much more individualised production. And that in turn could bring some of the jobs back to rich countries that long ago lost them to the emerging world.”

This is very exciting for the long term, but problematic for the immediate future. A much lower input of labour is Economistspeak for fewer jobs. Already, lots more stuff can be made with lots fewer people. This is classic Schumpterian creative destruction and, of course, deflationary.

Many, if not most industries are replacing jobs with technology. Retailing is undergoing radical downsizing due to internet buying. Big box stores like Best Buy and WalMart are shrinking. I’m told that Office Depot is going from one 30,000 sq. ft. store in an area to several units of 5,000 sq. ft. Hard to see more jobs coming out of this trend.

Fewer jobs means lower tax revenues. Our little town just announced the elimination of one fourth of the positions in our Public Safety Department. Your town is probably doing something similar.

Growth in corporate profits depends on growth of consumption, which in turn requires a growing workforce. Corporate profitability in this new era comes from technologically-based productivity increases which limit job growth. Until that changes, stock market valuations have to reflect low or no growth–they must go down. The Dow Jones Industrial Average is presently valued at 15 times earnings. A p/e ratio below 5 for the Dow is very likely before the bear market is over. And if earnings go down–as they must–it is going to be a bloodbath for anyone buying Barron’s expert’s opinions.

Cheers,

Rod

Clearing Up a Misconception (as if this were possible)

rodroth — Mon, 23 Apr 2012 13:34:47 +0000

He said, “Rod, you’re loaded up with gold, right?”

I said, “You think gold is going to go up?”

He said, “Heck yes, with all the money the government is printing now, inflation is going to soar, and gold along with it!”

This is a very smart businessman telling me inflation will be a problem, an article of faith he shares with every sentient being in the universe, it seems. I’ve heard it from all kinds of people, including any number of financial professionals. “With all those dollars the Fed is pumping out, it’s just a matter of time before inflation rears its ugly head!”

Offhand, I can’t think of anything more wrong, or backwards. We are in the midst of a horrendous financial environment, but it is a very destructive deflation, not inflation. Deflation started six years ago and it will persist for another twenty years or more.

The Federal Reserve Bank, a privately owned institution, can and does create more money when it buys bonds from the government and pays for them with new deposits to the treasury’s account. But the government’s obligation to redeem those bonds at maturity offsets the “new” money. If the government cannot pay off the bonds, the money disappears into thin air. The Greek government just defaulted on a hundred billion dollars worth of bonds. That money is gone, no longer available to levitate the price of spanakopita.

The same thing takes place throughout our commercial banking system when banks lend against deposits. With fractional reserve banking, banks only keep a small reserve against loans so, in effect, most of their loans are with money that is not there, which is the real inflation.

The textbook definition of inflation is an expansion of lending, which results in rising deposits, increasing the demand for goods. Lending activity has been expanding for over sixty years, which has driven price rises for most everything. Lending cycles are very long, but when they reach an unsustainable level, deleveraging (deflation) gets underway and it doesn’t stop until great masses of borrowed money disappear through paydown, foreclosure, default and bankruptcy. Loan expansion peaked in the US six years ago. Check what you might sell your home for today and compare it with comparable home sales in ’05. Deflated, right? Now check out the chart below:

The previous deleveraging cycle in the US was between 1933 and 1952. There were no meaningful price rises during that time. Oh, broccoli might be higher one season over the other owing to crop failure or an infestation of weevils, but the broad economy did not experience price inflation because lending was contracting.

We are in a new cycle of deflation. It is one degree of trend higher than the 30s, a Grand Supercycle deflation versus a “mere” Supercycle event. For at least the first few years of this era, gold, stocks, real estate, commodities, collectibles, art and anything else that passes for an investment vehicle will lose value against CASH, the asset investors presently love the least.

Not that I expect anyone to believe me.

Cheers,

Rod

How Market Tops are Formed

rodroth — Tue, 17 Apr 2012 16:43:30 +0000

Below is the chart I showed in my post of March 13 ( Top of the Correction at Hand):

Here is the same chart, one month later:

Breaking below the lower trend line is a strong indication that the top for this correction was made on April 2. The rallies over the past week are normal reactions to the new downtrend (if that is what we have). Often, a reaction rally will go back up and touch the trendline it just penetrated. Don’t ask me why, it just does. Ralph Elliott, the empiricist who postulated the Elliott Wave Theory, said it isn’t necessary to explain a market phenomenon. Observing it is enough.

Tops are diffused. The market starts down and then rallies to lower highs repeatedly because bullish sentiment prevails even though there isn’t much money around to drive the market higher. Today, investors and their advisors are fully invested and institutional portfolios have almost no investable cash on hand. The sentiment readings indicate the majority of investors are as bullish as they were at the October 2007 top. This is normal during a secondary high. Buying into it, or remaining invested here will be a hugh mistake.

The economic data is also coming in upbeat because social mood is driving both the market and the economy. We anticipated this back in ’09, when I wrote that I expected a rally and a recovery in the economy. Back then, the majority of polled investors (70%) were extremely bearish.

For perspective, here’s a look at the monthly chart of the S&P 500:

The Elliott Wave forecast is for a full retracement of the entire 1980-2000 bull market. We’ve got a long way to go.

Cheers,

Rod

Socionomics and Presidential Politics

rodroth — Tue, 10 Apr 2012 17:32:26 +0000

The socionomic hypothesis holds that social mood drives the collective activities in a society, including presidential elections. If social mood is up during a presidential year, the incumbent will get reelected. If it is down, the incumbent is out, usually by a landslide. The most reliable gauge of social mood is the stock market, so, given that the Wave Principle is forecasting a down market into the fall, we can anticipate that Obama will not be reelected.

The larger question, in my mind, is what we might be seeing when the next election rolls around. The major market cycles and the Wave Principle now indicate 2016 as the most probable year for the bottom of the Grand Supercycle Bear market underway for the past twelve years. It should be a very difficult time. The previous bear market of this magnitude occured in the eighteenth century. Like today, the global politics in that era were extremely contentious and the fury of the politically disenfranchised people–everyone but the elites–was extreme. The resulting angst produced two revolutions, the American and the French.

Should this time be any different? The only reason to think so is that we want to believe that middle class Americans are incapable of taking matters into their own hands and storming the Capitol in the manner of their forebears. I have to think anything is possible.

My real hope is that the era will produce statespersons who can galvanise the American electorate and clean house in both parties and get government back in the direction intended by the founding fathers. Unfortunately, when I try to imagine how things might go over the balance of this decade, the cynic in me thinks this outcome is even less likely than outright revolution.

My feeling is that the election this fall will not produce any significant change because, while the polls show little confidence in our elected officials today, there is not enough anger for revolution yet . I want to concentrate on who might emerge as viable candidates in 2016 when the mood is sufficiently negative to foster major change.

I voted Republican most of my life. I finally became disenchanted in ’08 and switched sides. For me, the outcome was no better. I don’t think any party deserves my loyalty now, so I’m looking for individuals who are independent thinkers and, hopefully, not aligned with the 10,000 Superzippers (http://rodroth.com/2012/02/20/on-the-american-project/) presently running the country for their personal benefit.

Here are two people on my list to consider:

New Jersey Governor Chris Christie (Republican)
http://wiki.ask.com/Chris_Christie

Elizabeth Warren, Massachusetts candidate for Senator (Democrat)
http://en.wikipedia.org/wiki/Elizabeth_Warren

I’d like your input on this. Send me your views on these people if you have any, and please send me the names of potential candidates you think might be good for the country.

I don’t intend to advocate for anyone in particular. I just want to gather and share the names of people that might be good candidates to represent a mandate for a complete overhaul of our broken system.

Thanks,

Rod

Goodby Gerber

rodroth — Sat, 24 Mar 2012 17:48:24 +0000

In the 21st century, the U.S. could be the slowly aging leader of a rapidly aging world.

—David Brooks, NY Times, 12 March

We hold that the huge population bulge of young people with little to do in Arab countries is a problem. That’s today. Tomorrow’s bigger problem is that the Arab world has joined much of the rest of the globe with birth rates that are suddenly, stunnningly below population replacement. According to the US Census Bureau, Iran now has a similar birthrate to New England–which is the least fertile region in the US.

Brooks writes: The speed of the change is breathtaking. A woman in Oman today has 5.6 fewer babies than a woman in Oman 30 years ago. Morocco, Syria and Saudi Arabia have seen fertility-rate declines of nearly 60 percent, and in Iran it’s more than 70 percent. These are among the fastest declines in recorded history.

It is no secret that Japan is aging, that Russia has 6 million fewer people than in 1992, and by 2030 there will be many more older workers (50-64) than young workers (15-29) in China, putting serious restraints on economic growth (sorry, China bulls). The big news, though, is the fact, inconceivable to perpetual population bomb worriers, that nearly half the population of the world lives in countries with birthrates below the replacement level. (http://www.nytimes.com/2012/03/13/opinion/brooks-the-fertility-implosion.html?_r=2&hp)

Not a good time to be in the baby food business. Or to be training to be a pediatritian, or an obstetrician, or a teacher, or a University, or, a few years from now, an employer desperate to find working age people to fill jobs. Population growth drives economic growth and we are seriously short on baby making now.

This downtrend in birthrates is the most compelling evidence yet of a Grand Supercycle downturn in social mood. Imagine the hysterics when today’s stock investors realize that the stock market, at 25 times earnings, is priced for growth that ain’t gonna be happenin’.

Observations

Speaking of hysteria, the notion that we are running out of oil is worth noodling over. The hedge fund-driven speculative oil bubble has run up the price enough to have oil men furiously drilling out West and fracking back East, with the mostly unadvertised effect that we’ve got scads of oil now. The Elliott Wave Financial Forecast reports that the US is now “the closest it has been in almost twenty years to achieving self-sufficiency.” Pipelines designed to pump oil and gas into the US are now being reversed to pump oil out. This at a time when US consumption of oil and gas is headed steadily downward.

Once again, oil proves to be just another commodity with boom-bust cycles. I see no reason to alter my idea that gas will be closer to a buck than two bucks a gallon by 2016.

Cheers,

Rod

Top of the Correction at hand

rodroth — Tue, 13 Mar 2012 19:54:17 +0000

Corrective waves are, more often than not, ambiguous until the very end. In fact, they can seem to be at their very end, and then fool the analyst, as this one certainly has.

That said, I can make a case that the final top is going to be in the area of 1405-20 in the S&P 500 Index. The corresponding high in the Dow Jones Industrial Average is 13,400-500.

The rally from 11/28 has traced out 4 complete waves, the longest being wave 3, from 12/19 to 2/29.

Wave 4 bottomed on 3/06, and we are now in the fifth wave.

I calculate the probable top by first connecting the ends of waves 2 (12/19) and 4 (3/04) and then drawing a line north from the end of wave 3 (2/29) that creates a parallelogram with the lower line. If volume is heavy today and tomorrow, I would expect a brief throw over through the upper line and immediate collapse. If volume remains low as it has been lately, the upper line ought to contain the move. Either way, we should look for Elliott Wave 3, the most ferocious decline in many years, to get started shortly:

Cheers,

Rod

Regarding Our Attachments

rodroth — Tue, 28 Feb 2012 19:04:38 +0000

A false sense of security is the only kind there is
—Unknown

It wouldn’t be so bad for him if things weren’t so good. His business, on the ropes eighteen months ago, has recovered and then some. He is fully staffed again and the work is not getting done in timely fashion, so he considers adding more staff. But what if this is a last gasp run prior to another collapse? He is up nights, worrying about making the right moves and, even more, about risking failure again–he’s had enough of that.

This is the story of the moment. Particularly so with established careers and enterprises. “Looking back,” he tells me, “it was easier when we were struggling to get going. We had no downside because we hadn’t gotten off the ground yet. I think building the business was the most fun!”

So the problem is not the work, which we love and are good at. The problem for millions of us is that we’ve attached ourselves to a lifestyle with responsibilities that cannot be met unless our income is maintained. Mortgages, college educations, really just the basics, but what lovely basics!

The sage tells us to lose our attachments and become totally engaged in the discovery of our authentic selves through our work and our relationships, and we say “How do you do that if you can’t pay the bills?” Don’t pay ‘em, he says. It’s a liberating experience.

Perish the thought, I say. But I also know that I don’t know what’s best for me. Everything that I cherish has been an unexpected gift that evolved from a life circumstance that I never would have planned for myself.

My suspicion is that, dead ahead, is the best time of our lives. “Lord, that I be tested,” goes the prayer. Coming right up.

“Right now,” says author, mythologist Michael Meade, “the culture is unraveling and nature is being rattled to its core, there is little security in existing institutions, and coherent stories are increasingly hard to find.”

In view of this, he says, “At this point if we’re going to discover the deeper myth of America, I think it may have to come from the older people. And it’s not the freedom of an oversized house and a stock portfolio. That’s simple aggregation. It’s the freedom to live a passionate, imaginative, meaningful life right up to the last moment.”

The question is, if we can’t do this on Boeuf Bourgignion, can we do it on chitlins’ and collards?

Observations

We have to get up in the morning and we have to go to work. But we don’t have to be invested in the stock market. “What would it take to change your bearish stance on stocks,” he wants to know?

Extremes, I say. Extreme pessimism, extreme low valuations, extreme and complete liquidation by the public. All of the rallies since 2000, including this most recent one, have been corrective in nature and part of a great top building, which is appropriate for a top of this magnitude. The declines, on the other hand, have been impulsive. As long as this is the condition, making and keeping money in the market will not be possible.

Cheers,

Rod

On the American Project

rodroth — Mon, 20 Feb 2012 11:59:06 +0000

A large part of the problem consists of nothing more complicated
than our unwillingness to say out loud what we believe
–Charles Murray

Charles Murray’s goal in his new book, Coming Apart, the State of White America 1960-2010 is “to induce recognition of the ways in which America is coming apart at the seams–not seams of race or ethnicity but of class.”

Not surprisingly, the ink on the book was hardly dry before liberals began screaming “Foul!” Murray, a libertarian, has been a pariah among liberals ever since his first book, Losing Ground, published in 1984, led to a complete restructuring of America’s disastrous welfare system.

The author’s focus in Coming Apart is the evolution in the last fifty years of two new classes: the new upper class, and the new lower class, which together are imperiling what he terms the American project–the continuing effort to demonstrate that human beings can be free as individuals to live their lives as they see fit, coming together voluntarily to solve their joint problems.

Tocqueville observed that Americans thrive in democracy because they naturally share four values: Industriousness, Honesty, Marriage, and Religiosity. Murray writes that the new lower class is steadily abandoning these values, and the new upper class exacerbates the problem by its failure to understand this.

Murray’s description of the condition of the new lower class is disturbing. These are Americans who have abandoned the core values Tocqueville observed long ago, in favor of living dissolute lives.

The new upper class has a subset Murray labels the narrow elite, numbering not more than 100,000. These are the people who run the nation’s economic, political, and cultural institutions. This is the cohort who most influences and makes social policy. Because they congregate in what Murray calls Superzips-enclaves of high wealth, education and priviledge, they are physically and culturally isolated from the new lower class, thus oblivious to the conditions and mores of the people for whom they legislate.

The new upper class has liberals and conservatives in their number. Their debate on how to solve the social issues plaguing the country is ineffective because it revolves around how much welfare should be extended. The real issue is how to restore among the new lower class the old ideals: that any kind of honest work is self-actualizing, and that family and faith are the bedrock values for personal happiness. In short, the discussion needs to be about what should be done to create social capital in the community of the new lower class.

The core values are alive and well in the new upper class. However, the unseemliness in many of their life-style excesses diminishes their ability to be the standard bearers for America’s wonderful traditions.

In most parts of the country the new lower class is barely visible, making it easy for those of us who remain culturally in the middle class to say its not our problem. It becomes our problem when the crime, the exploding prison population and indigent health care costs of the new lower class put an ever rising tax burden on us.

The American project is in trouble. Rather than present solutions, Murray suggests two ways in which the future of the nation might evolve–one pessimistic, and one optimistic. What we all do in the years ahead will determine how this plays out.

Coming Apart is an important description of a society in peril. If you are reading this, you have a stake in the outcome. Now more than ever, I believe, Americans should consider the state of our community in a thoughtful way and vigorously engage the issues wherever we can. Reading Coming Apart is a good start on the matter.

Cheers,

Rod