Credit Markets for Dummies / Bankers

Last week, I was complaining about the idiocy of the CEO's of the major banks in their sub-prime and general end-of-cycle lending practices. Although I thought that these folks should be smart enough to understand cyclical risk in mortgage lending, apparently it has escaped them.

While your servant is just a humble real-estate appraiser in his real life (and a former branch manager for Household Finance), I didn't think understanding changes in real estate values or basic credit lending (and hence, value at risk for a bank) was too complicated.

Apparently, though, I was mistaken. Hence, my new class, Credit Markets and Residential Real Estate Values 101. Now, I want the heads of Citibank, Bank of America, et.al. to stop goofing off, and sit at the front desks here.

Prince! Up Front!! What? You've been canned? (oops, "resigned under pressure") Well, all the more reason to sit up front here. Now pay attention!

This is pretty simple.

1. First of all - don't lend to people who can't afford to repay you - yes, over the long term - not just based on the teaser rates!


2. Check their references - i.e. confirm their income, debts, payments, etc.


3. Medium-to-longer term changes in real estate values (which is really what the bank's security is predicated upon) is based almost completely on just three factors. Pay attention to those factors, since they can affect values!

The three factors affecting the medium-term plus value of real estate are:

a. Changes in population in an area;

b. Changes in after-tax income;

c. Changes in interest rates.

Prince, note that unsustainable changes or trends (as an example, interest rates at historic or near historic lows, eg 2001-2005) will have the effect of exagerating short-term property values. Meaning, in the context of real estate values, circa 2002-2007, they are likely to become OVERSTATED due to "c" above. And thus impair balance sheets.

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No one could have predicted this? I pull some narrative commentary from my own appraisals dealing with values in 2003 ...

"... the local housing market continues to set records, fuelled by both low interest rates, and a relative shortage of product."

... in 2004 ...

"Lending rates remain at near-historic lows, and continue to support economic activity of all kinds, but low rates are well-known to provide significant boosts in pricing and activity in the housing sector."

... and in 2006 ...

"Lending rates remain at near-historic lows, and continue to support economic activity of all kinds, but low rates are well-known to provide significant boosts in pricing and activity in the real estate sector."

Prince, Prince!! Pay attention.

JW

The Confused Capitalist

Dancing Hippos - Inflation and Subprime Cleanup

The "unforeseeable" crash in the sub-prime market has resulted in central banks around the world both lowering their lending rates, and to agreeing to co-ordinated activity to ensure the credit markets don't freeze up again.

Unfortunately, while necessary, this has all the hallmarks of weening the alcoholic off the juice, by just letting them have a little bit more to limit the potential for the D.T.s

I still don't understand how most of these large banks got caught up in the lending to extreme value-to-loan ratios that characterizes the end of many mortgage lending cycles. Were ALL the CEO's drunk? Can they not figure out what lending at low rates for long periods of time does for real estate prices? Do they not read? Are they completely ignorant of both Econ 101 and history? Can they not predict a cause and effect scenario for real estate values? Are they stupid? Unable to think for themselves?

Keeping Fed Rates at 2% or below, as was done from Nov 6, 2001 to Dec 14, 2004 for over three years, is unprecedented in the past fifty years. In the late 1950's and early 1960's, there were three periods where the Fed Rate was 2% or under, but none of these periods exceeded 9 months in duration. (See for yourself).

A simple scaling-back of loan-to-value ratios as rates began to rise - and in response to the booming real estate price increases - would have both protected the banks capital and balance sheet and, as a group, protected society from this mess. Instead, we're all destined to pay for this fiasco, surely through higher inflation rates, if not in other ways.

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Ultimately, the unwinding of the party of these drunken sailors will have implications on nascent inflation, something that'll probably take even longer to unwind than the couple of years the credit market will be in the sick bed for. One of these two "dancing hippos" may well cause further damage as they twirl about the room with abandon.

Aside from Greenspan, there are many others implicit in this whole mess, including a lot of people who should know better. Maybe Citigroup et. al. needs to open its own form of McDonalds "Hamburger University". Credit Markets 101.

Merry Christmas - bah humbug!



JW

The Confused Capitalist

Betcha a $Billion or two ... Warren Buffett buys more bank stock

Filings covering the period ending September 30 2007 showed that Berkshire Hathaway added to stakes in three large U.S. banks with increased stakes in Wells Fargo & Co (NYSE:WFC), U.S. Bancorp (NYSE:USB) and Bank of America Corp (NYSE:BAC).

Between then and now, prices in two of those three banks fell by around 10% at one point or another, while stock in US Bancorp was available at around the same price as its lowest price in the quarter ending Spetember 30th.

Given Mr. Buffett's well-known penchant for buying discounted, out-of-favour stocks, do you think his next filing will show he added to those positions with his ~$40 Billion cash hoard?

Betcha a billion or two he did.

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JW

The Confused Capitalist

Sectors Still Look Poised for Outperformance

Back in August, right near the bottom of the mini-plunge, I suggested several sectors whose stocks looked poised for outperformance over the longer term, as well as a couple of groups to avoid.

The groups I liked included some of the bigger banks (although I warned that further declines of 10-20% also looked possible), whose yields were then in the 3.4% to 5.0% range or so.

They also included some of the large engineering firms, who I see as prime beneficiaries of the design and oversight work needed to build out the emerging markets infrastructure, and the work needed to replace the aging infrastructure of the western world.

It also included several emerging markets suggestions, and a later posting suggested that distressed credit buyers would have the opportunity to load up their balance sheets with cheap debt, which could fuel earnings for years to come.

Since those predictions, the S&P 500 has bounced up and then down, and is essentially flat over that period.

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The banks mentioned have generally declined, most by about 10-20%, but with Citigroup getting trashed. On the other hand, some have held up pretty well, considering the magnitude of write-offs announced since then. I still like them, and now most of the yields are now in the 5-7% range, making them even more attractive in the face of what I see as a weak market. Maybe it's just me and Warren Buffett who like the bank stocks at these prices.

Engineering firms still look good as a look term-prospect, but this may be somewhat tempered by the fact that most of those discussed have moved sharply upwards, by 10-50% since then.

The emerging markets suggestions have also moved up, by about 15-20% on average of the group discussed.

Finally, a later August 2007 suggestion of looking at some distressed credit buyers is essentially flat as a group.

I still like all of these groups, and think that current prices are likely to look good several years from now.




JW

The Confused Capitalist

Food Inflation will continue and accelerate

I have written several times about my belief in a movement towards higher food prices in the future, perhaps much higher than in the past. Some commodity experts like the renowned Jim Rogers have stated this belief too.

While I normally enjoy helping investors think about long-term trends that'll help fatten their portfolios, because of the implication this trend has for people everywhere, especially poor people, this posting gives me absolutely no joy.

Nevertheless, here's several ways to invest in what I believe is a long-term trend towards higher food prices:

Van Eck Global's fifth ETF, Market Vectors Agribusiness (AMEX:MOO), which recently debuted and is already up nearly 20% since then. The ETF includes subsectors of the agriculture, such as agricultural chemicals at 34.3% of the index, agriproduct operations, 33.5%, agricultural equipment, 24.3%, livestock operations, 5.6%, and ethanol/biodiesel, 2.3%.

The 40 companies from 13 countries in the index must have a market cap of at least $150 million and a monthly trading volume of 250,000 shares. These companies are primarily engaged in the business of agriculture, and must derive at least 50% of their total revenues from agribusiness. According to information on the fund sponors site (Van Eck), as of Sept 2007, the fund had a PE of ~27, a PB of ~3.5, and a dividend yield of 1.06%.

There are also several ways to invest more directly in the foodstuffs, either through ETFs or ETNs. Two recent products from Barclays (ipathetn) are as follows:

"JJA" tracks the Dow Jones–AIG Agriculture Total Return Sub-Index. The Index is currently composed of seven futures contracts on agricultural commodities traded on U.S. exchanges. The weightings are currently as follows: Coffee 8.0%; Sugar 7.0%; Soybeans 28.0%; Wheat 23.6%; Soybean Oil 9.9%; Cotton 9.3%; Corn 14.3%. According to the information provided by the sponsor, the annual return from the index looks like this: 1yr = 44%; 3yr = 12%; 5 yrs = 6.2%; 10 yrs = -(minus)1.7%.

As you can see, owning the index constituents would have been very good during the past year, and very lousy over the past 10 years.

"JJG" tracks the Dow Jones–AIG Grains Total Return Sub-Index, which has an underlying composition of three futures contracts on grains traded on U.S. exchanges. They are weighted as follows: Soybeans 42.6%; Corn 21.6%; Wheat 35.8%. According to the information provided by the sponsor, the annual return from the index looks like this: 1yr = 64%; 3yr = 14.9%; 5 yr = 6.4%; 10yr = -(minus)1.4%.

Judging by the return differences between the two products over the past year, it appears that the Grains component of the "JJA" ETN (which is 66% of that ETN) has provided almost all of the 44% annual return; in fact, my calculation shows that it's responsible for 41 points of the 44% return.

PowerShares also offers a foodstuff type ETN, DB Agriculture; "DBA".

It tracks the Deutsche Bank Liquid Commodity Index - Optimum Yield Agriculture Excess Return. The index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities – corn, wheat, soy beans and sugar, in equal weightings (i.e. 25% each). However, the weightings in the fund are only periodically rebalanced, and as of October 25 2007, the weightings had changed to as low as 17% for sugar and as much as 31% for soybeans. Index return history as of September 28 2007; 1Yr = 36%; 3yrs = 15%; 5yrs = 11% and 10yrs = 1.6%.

This ETF started trading in January 2007 at $25 and closed at $29.28 on October 26 2007, providing a 17% return since that date.

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Finally, according to recent press releases and web-articles, ProShares is going to be offering a leveraged ETF tracking the Dow Jones-AIG Agricultural Index. When they start trading, this will offer the opporunity to track the index, but on a double-leveraged basis. The release date of the ETF isn't known at this time. Expect a one to four month delay as typically seen.

I have written previously about the food inflation issue, and it's worth re-visiting two of my postings, here and here for more background.


JW

The Confused Capitalist

Move out of both the US and Canadian Dollar?

Sometimes, you've got to recognize good fortune and take advantage of it. Other times, you've got to move to avoid trouble.

For my blog readers, who seem to be mostly a mix of my fellow Canadians, and my "American Cousins" (yes, I really have some), it seems to be a time for both.

Firstly, the Canadian dollar is now trading at high levels, and just today punctured levels not seen since the currency starting floating in 1970. In other words, a modern era record high. So it may seem unusual that now is the time I'd begin suggesting that it's appropriate for my fellow Canadians - likely with much of their wealth invested in Canadian companies - to begin looking outside the country.

However, while I fully expect that the currency may well continue its climb, prudent investing requires re-balancing, particularly when something has appreciated dramatically. A once in a 37 year event (record high currency) qualifies.

So, I'd suggest that many of you start looking at ways to diversify at least some of your investment portfolio outside of Canada. While this might hurt returns over the short term (no one can really "call the top" of any currency assent), it looks to me to be a prudent move over the longer haul. In other words, buying international assets when they look cheap to us.

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Secondly, for my American Cousins, unfortunately, I wouldn't recommend getting more heavily into US assets at this time. Let's face it, the American fiscal situation is a mess, with the national debt at unprecedented levels (roughly $27,000 per person) and projected to continue growing, and many Americans themselves hampered by heavy -unprecendented really - levels of personal and mortgage debt.

Combine these twin bombs of debt, personal and federal, with many recent announcements by central banks the world over that they intend to reduce their holdings of US currency, and where do you think the currency is headed?

Or perhaps another way to put it would be: Do you really think you're smarter than the these central bankers who are leaving the US currency like a plague?

So, to both my fellow Canadians and my American cousins, I think that now is a good time to begin looking at other internationally-denominated investments. Reducing exposure to your Canadian or American assets at this time seems prudent, and likely to boost long-term returns.


JW

The Confused Capitalist

Thinking Ahead: Ten Years Out

One of the themes I've tried to engage readers in here, is that by playing some fairly obvious trends, and coupling those with reasonable valuations, is a relatively easy way to outperform the market.

One theme I've pounded on over the past one-and-a-half years is the emerging market theme. It doesn't take too much heavy lifting in the thinking department to realize that with soaring GDP growth rates of 8-12% annually in some of these countries, expecting their stock valuations to follow isn't much too much of a mental stretch, even for weak thinkers like me.

So, thinking ahead, and about 10 years out is a good target, it becomes much easier to think that an overweighted emerging markets position is likely to be both prudent, and very profitable. Now, the graphic above showing firestroms in California (currently displacing one million people) obviously suggests that this posting isn't about emerging markets.

That's correct - this is about alternative energy production. While climate change and global warming have been warned about and was easily readable in the popular media 20 years ago(Time Magazine, for instance, awarded Planet Earth as "Man of the Year" in 1989, due primarily to concerns about global warming), it's only recently that most people are finally waking up to the severity of the problem.

As the problem continues to grow in the public mind, so too will the demand for solutions. These will be invoked on a political and individual basis. As the negative consequences of inaction become more and more and more visible and the predictions more dire, many will begin making personal change AND demanding societal change. This is inevitable.

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What is also inevitable is major changes to our type of energy consumption and to the pattern of use. For instance, emerging economies will begin to use far more energy than in the past. This is good for them, but not good for the planet. The energy hogs of the planet - that's us in the western world - will finally begin to reduce consumption outright - not just on GDP weighted basis. Since we were "first in" to this pattern of inefficient energy use, it also is right that we strive to be "first out" of the pattern.

This brings us to our investment opportunity. Looking ten years, does anyone see a world in which the general populace isn't pressuring the politicians to fund alternative energy, to create incentives/disincentives to change energy use, and possibly even to restrict certain types of energy use? Perhaps rationing, a popular method for "spreading the pain" and acknowledging that we're all in this together, will become popular.

In any case, I personally cannot envision a world in 10 years where alternative energy isn't a significantly larger economic sector than it is today.

Of course, my much beloved ETFs provide a way to play this trend while avoiding single company risk. The recent launch of three ETFs targeting this sector might lead some to utter the usual cliques and say that this is a clear sign that this market segment has "topped". Yet the reasonable valuations, societal trends, and my common sense, tell me "no", that is not the case at all. And that is why I am willing to significantly overweight my portfolio to this segment.

While I do not pretend this is a comprehensive list, here are three ETF names in this sector:

Market Vectors Global Alternative Energy ETF (GEX) started trading on the New York Stock exchange. The fund, tracks the Ardour Global index (Extra Liquid), which is comprised of stocks in 30 publicly traded companies engaged in alternative energy production. These stocks are selected from a stable of 250 companies in this space. At least 30% of the names are not US-domiciled companies, and may therefore be attractive to those wishing some diversification out of the US currency. It is however, a relatively concentrated ETF, with 60% of the value being held in the top ten positions. Yahoo Finance shows the current PE as ~30.

Power Shares Global Clean Energy Fund (PBD) is based on the WilderHill New Energy Global Innovation Index. The Index seeks to deliver capital appreciation and is composed of companies that focus on greener and generally renewable sources of energy and technologies facilitating cleaner energy. The modified equal weighted portfolio is rebalanced and reconstituted quarterly. It currently holds 84 positions. It also has limited exposure to US companies, with only 26% of the ETF having US domiciled companies. Yahoo Finance shows the current PE as ~26, while information from PowerShares says the PE is ~42.

Finally, an all US domiciled companies is the First Trust NASDAQ Clean Edge ETF (QCLN)which started trading in February, covers five sub-sectors of the alternative energy industry: renewable power generation, renewable fuels, energy storage and conversion, energy intelligence, and advanced energy-related materials. The investment has above average concentration, with the top ten positions holding 55% of the value. It seeks to track the NASDAQ Clean Edge U.S. Liquid Series Index. Yahoo Finance reports the PE as ~25.

One caution with all of these ETFs is that they are presently quite small, none having assets of more than $100 million. But I predict that will change dramatically by the time 2017 has rolled around. Clean energy - a future whose time is now for the investor.



JW

The Confused Capitalist

A random musing: profit margins

Much of the recent thoughts as to why we are heading towards a bear market - other than the usual phalanx of bears arguing the "edge of recession" - have centred on the extraordinarily high level of profit margins, arguing that this can't go on forever. As put succinctly:

"Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly."

- Renowned Investor Jeremy Grantham

In essence, the bears argue that while the "PE" looks fine, the "E" in "PE" is bogus, and not supported by sustainable metrics. However, most marketplace observers cannot offer a compelling reason why margins have continued to grow (although there is some rationale offered here that makes some sense) at the back end of a long bull market. While I have no doubt that the lengthy margin expansion will reverse at some point, I wonder if corporate conservatism is having some impact.

That is, typically during most other bull markets, fat profits led company managers to buy into so-called "complementary" (not really!) businesses through buyouts and mergers, with poorly focused conglomerates emerging. This, I suspect, led to much poor business practice, including a focus on revenues, instead of contribution to the bottom line - i.e. margins that are accretive to earnings.

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However, the business mantra today is single-minded focus, "the mission" of the business if you will. Not much room for sloppy, drunken, buying binges that are covered up by growing ill-thought-out revenues, even at the expense of declining earnings and/or margins. Today, excess cash is more often deployed through share buybacks and, to a lesser extent, cash dividends.

With that thought in mind, I wonder if the button-down managers of today are primarily responsible for continued profit margins at extraordinarily high levels? And if so, for how long will they be able to keep up the admirable restraint before they, as a managerial collective, feel compelled to sow the seeds of their managerial genuis?


JW

The Confused Capitalist

The people have spoken - well 15 of you anyway ...

In relation to the recent poll on the site (now removed), the people have spoken (well, the 15 who responded, anyway). Compared to the S&P500 close on September 17 2007 at 1,476 (closed on Friday September 28 2007 at 1,525), most readers felt that it would reach lower depths at some point within the period ending six months out (March 17 2008):

• 27% said it would have touched a point at least 25% lower;


• 27% said it would have touched between 12% to 19% lower;


• 33% said the dip would be relatively minor, between 0-12%


• 13% said that it wasn't going any lower - that 1476 would be the low water mark over that time frame. So far anyways, those who chose this option have been correct, as the market gapped up the next day on the back of the FED rate reduction and waved good-bye to 1,476.

Interesting, but obviously not scientific in any way, given the self-polling aspect, and tiny sample size.

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JW

The Confused Capitalist

Where is the S&P500 headed? Poll here.

Got any idea where equities are headed over the next six months?

If you got an opinion as to what the low point in the market is going to be over the next while, why not take the poll on the right hand side of the blog? (Please be a bit patient, as the poll takes a little bit to load ... a 10-20 seconds for high-speed connection)


I'll report out on the results in a few weeks. Thanks to everyone who participates.


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JW

The Confused Capitalist

Fundamental vs Cap-Weighted Indexing Debate

I have written many times about moving along with better investing, thinking about long-term themes that will improve your investing results.

One of those themes, for passive investors, is to use low-cost products, like ETFs or index mutual funds. For the average investor, this will produce better than average results. Another theme is to use those same type of products that mirror some type of fundamental, as opposed to capitalization-weighted index.

John Bogle's (creator of the Vanguard mutual fund behemoth) back-testing research several decades ago that showed that most investors would be better off in funds that simply mirrored the then best market indices available, but at the lowest cost. However, times move on, research advances and other indices are created and tracked.

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The ones that are outperforming the conventional capitalization-weighted indices (like the S&P500, the Dow Jones Industrials, etc.) are ones that track fundamentally-weighted indices. Products, such as low-cost ETFs, are then modelled on those indices. Some of the indices or products are the RAFI indices, and the Wisdom Tree series of products.

RAFI indices consider the economic footprint of the companies it tracks (rather than it's stock market value) and in back-testing, those indices generally outperform the more popular by a significant margin. They've also generally outperformed since various products modelled on them have been produced over the past several years. The Wisdom Tree series of products generally looks at the dividends paid as a fundamental weighting, and models products based on that. Notwithstanding its weakening relation to companies that outperform the average capitalization weighted index, it is still a decent predictor of outperformance.

Anyone wanting to understand this further can go to a debate among three leading proponents of the various styles - Rob Arnett for RAFI indices, Jeremy Siegel for Wisdom Tree, and Gus Sauter, Chief Investment Officer for Vanguard - here.

An interesting and enlightening debate, and well worth the read. I have also written about fundamental indexing here, and here.


JW

The Confused Capitalist

Emerging Markets hold the line in equity decline

Has the egg finally cracked?

I postulated, last year, that emerging markets were a better value proposition that widely acknowledged, with their strong economic fundamentals, and solid government financing, in sharp contrast to most western nations, and particularly the US.

The WS Journal chart below (via Barry Ritholtz's Big Picture), shows that, globally, the emerging markets were the only major stock group to end the week in an up position.

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Perhaps this is the start of the trend I've envisioned, wherein emerging markets, and the developed nations, re-balance to more appropriate valuation ratios, based on the conditions actually in existence today.

Or perhaps this is just a short term blip ...

JW

The Confused Capitalist

Dividend Yield versus Payout Yield - Part II

Weighing payout behaviours ...

In an posting made last month, I commented on the rising importance of payout yield versus dividend yield ... I just ran across an article in CFO magazine that perhaps explains part of the reason why dividend yield is declining as a predictor of future outperformance.


To quote ...

In 1980, for example, the value of stock buybacks exercised by S&P 500 companies equaled just 10 percent of the value of the dividends issued, according to Scott Weisbenner, a finance professor at the University of Illinois who studied the issue while serving as an economist at the Federal Reserve Board from 1999 to 2000. By the late 1990s, however, companies were spending more on repurchases than on dividends.

And the boom continues: in the second quarter of this year, buybacks outpaced the same period a year ago by 43 percent, while dividends accounted for just 32 percent of cash paid out to shareholders, down from 51 percent as recently as the second quarter of 2001. Weisbenner also found that between 1994 and 1998, the use of stock-options programs by S&P 500 companies grew by more than 40 percent.

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The rest of the article - which is primarily about the morality of company insiders selling into share buyback plans - can be accessed here.




JW

The Confused Capitalist

The Upside of Declining Consumer Confidence

The Conference Board reported that consumer confidence dropped in August, giving up nearly all of its July gains.

As the Conference Board reported it ...

"A softening in business conditions and labor market conditions has curbed consumers' confidence this month. In addition, the volatility in financial markets and continued sub-prime housing woes may have played a role in dampening consumers' spirits. But, despite less favorable conditions and in spite of all the recent turmoil, consumers still remain confident. And, current Index levels suggest further economic growth in the months ahead."

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It was reported that this was a prime cause of weakness in the stock market today. Despite notions to the contrary, declining consumer confidence is a good, healthy response to the indebtedness of both the consumer, and the federal government.

Acting otherwise would be a denial of reality. For those soundly in the bullish camp, let's review some facts:

1. Household debt at unprecedented levels;
2. A negative household savings rate, something never seen in the midst of an economic expansion;
3. Federal government debt at the highest levels in recent memory, and still growing;
4. The continuing trade deficit;
5. The prospect of a continuing decline in the currency, meaning the Fed has to continue to walk the tightrope between importing inflation on the one hand, and managing the orderly decline of the currency on the other. All the while trying to massage the debacle in the credit markets. An undertaking fraught with short and/or long term risk. Take your pick.

Yes, there's times to be confident, like when things are humming along really well. This isn't one of those times. Then there's the confidence that comes from having been in a place of despair, but when the trends are moving in the right direction. This isn't one of those times either.

Now is a time to make sure you get your own financial house in order.

Start with the basics - your household budget. Review it for unnecessary expenditures. Trim your debt levels, with the most expensive interest rates first. Save some money! Use a high yield account, or find some solid blue-chip stock prospects, or broad-based ETFs. Save (anyone remember the word?) ... save ... save ...

In short, the upside of declining consumer confidence is the ability to not to be a monkey brain - to recognize the potential for trouble (like now), and put some preventative personal actions in place. While the trouble may or may not materialize, planning and acting like this will serve you well in any case. Now isn't the time to be an overconfident consumer - its' the time to be a confident saver!

Don't be blind to reality - open your eyes, look around, think, plan, and act. Are you a monkey?

JW

The Confused Capitalist

Distressed credit buyers opportunity?

They say it's an ill wind that blows nobody good - meaning that even in times of turmoil, there's often someone who's situation is improving.

With that thought in mind, I recalled the recent turmoil in the credit markets, and wondered what companies might benefit from this situation. Leafing through my investment scrapbook, I came across an entry I made some two years ago, suggesting that if the US debt situation imploded, that a beneficiary might be those whose business profile sound like this ...

... provides outsourced receivables management and related services in the United States. It engages in the purchase, collection, and management of portfolios of defaulted consumer receivables. The defaulted consumer receivables are the unpaid obligations of individuals to credit originators, including banks, credit unions, consumer and auto finance companies, and retail merchants. It also provides collateral-location services for credit originators, collections and revenue administration, and audit and debt discovery/recovery services for government entities.

... in other words, those who benefit from a higher default level on any type of consumer debt, since a higher level of delinquency is inevitable, given the negative savings rate of the average American family. Given that, opportunities to load up the balance sheet for these companies with cheaper than ever defaulted debt, at favourable prices, appears better than in recent memory. This could fund very profitable growth for these companies for some years to come.

Some names in this space include:

Portfolio Recovery Associates - PRAA
Encore Capital Group - ECPG
Asta Funding - ASFI
Asset Acceptance Capital - AACC
First City Financial - FCFC

This is an idea worth exploring more for your own portfolio, if you think, as I do, that the ill wind is blowing towards these companies right now.

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JW

The Confused Capitalist

Dividend Yield and Payout Yield

Confused Capitalist readers know that I'm a fan of dividends, and consider them to be one of the stronger indicators of a firm who's total return is likely to outperform the broader market into the future.

While the above remains true, one also has to consider the net payout yield, which is the total returned to shareholders by dividends and by the net of share issuance's and re-purchases.

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There's more and more evidence available to suggest that this is even a better predictor of excess future returns than dividend yield alone. Here are two resources in that regard:

World Beta Posting and PayoutYield.com



JW

The Confused Capitalist

What Greenspan has wrought ... the current market environment

Barry Ritholtz at the Big Picture has exactly nailed the problems that the Fed faces in attempting to manage this market so that things remain orderly. Rather than re-iterate them, I direct you to Barry's posting.

... Pay particular attention to the "while avoiding" part of the posting, and try to think how you can construct your portfolio to take advantage of those very distinct possibilities.

JW

WallSt.Net Podcast

Welcome to everybody from WallSt.net who came over here because of the podcast interview with Dennis Olson (Haven't heard it? Go here; it'll be on their site on Wed. Aug. 15th). Thanks to Dennis and WallSt.net.

This posting is essentially related to some stuff I talked about on the podcast.

Firstly, anyone interested in buying my book can go here.

Secondly, in terms of some of the stuff I talked about in the podcast about why this blog is a bit different than many out there, I mentioned specifically, dividend investing, and long-tail investing. Here's a couple of articles I've posted that kind of give you a bit of the flavor of these topics, here, here and here. And for those who know me and my bent towards value investing, I re-submit this evidence ...

Now, in terms of stuff I specifically recommended (either avoiding, or moving towards) ...

AVOID

Real estate stocks, especially home-builders (see the reasons why, in an article I wrote in my other life) and avoid sub-prime lenders; the first for three to five years; the second for two plus years. Pessimism after that will be prevalent and then would be the time to buy. There's still too much optimism in the market.

BIG BANKS

Conversely, the really big banks are getting tarred with the "sub-prime" brush, which isn't warranted, in my view. Many of these institutions are tremendously strong, with great balance sheets and will easily weather this storm, and perhaps come out of it with better than ever opportunities. They're also paying great dividends right now, and most have raised their dividend recently. This is another sign that they are probably being mis-priced in the market. Some to look at would include:

• CITIGROUP - yielding about 4.6%



• Wells Fargo - yielding about 3.4%



• Bank of America - yielding about 4.6%



• Wachovia - yielding about 4.6%



• US Bancorp - yielding about 5.0%

Of course, those risk-takers might wait for the next mini-plunge which, if it occurs, might raise these yields by another 50 to 100 basis points (i.e. prices might fall by another 10-20%). However, I think they're good enough deals as they sit. Don't delay too long on these folks - "on sale" today!

EMERGING MARKETS
Emerging markets remain a very-long-term theme that investors will be able to successfully play for a decade at least (provided the stocks don't get overpriced). On a purchasing power parity (PPP) basis, these economies currently account for about 20-25% of world trade, yet most conventional financial advisers suggest a 5% weighting or so. This is a serious backward-looking mistake. No investor with a 20 year horizon can afford to take such a light weighting in these strong growth markets.

While the conventional BRIC countries have been bandied about as "the" emerging country investment destinations, other countries also have strong profiles too. A personal favourite of mine remains South Korea, with nearly an "emerged" economy, yet very cheaply priced.

Here's some ways to play the emerging markets theme, via ETFs, in my personal order of preference:

• Wisdom Tree's ETF - "DEM" - a dividend-weighted emerging market ETF. This ETF should prove more resilient than many emerging market investments during market corrections, while retaining most of the upside during exuberant bull markets.


• The Claymore Investments ETF - "EEB", which is designed to provide exposure to the BRIC countries, through ADRs. Because ADR issuers tend to be large, liquid companies, this also reduces some risk.


• The iShares S.Korea ETF, "EWY" - a narrow singly country focussed ETF.


• The iShares Emerging Market ETF, "EEM" - a very broadly-based emerging market ETF.

AGRICULTURAL COMMODITIES

I think this sector is going to have a huge tailwind going forward, something I've written about here. In later postings, I'll elaborate on how to play this trend.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!


INFRASTRUCTURE BUILD OUT

This is tied in with several other trends, including the re-building of the industrialized world's infrastructure to make it greener (using mass transit for instance, to replace the crappy aging stock of roads and bridges).

Also, the infrastructure build out in the emerging markets is something that's going to continue to occur during the next several decades. For instance, the Chinese GDP per head is about 1/4 of what it is in the US (on a PPP basis), while in India it's about 1/10 (PPP basis). These economies will also obviously be building out their infrastructure. Accordingly, I like some of the very large manufacturers, like General Electric ("GE") & Siemens AG ("SI"), but I especially like the engineering firms that'll obviously be beneficiaries of the design and over-sight work needed here. Some names in this sector include:

• Fluor Corp. - FLR


• Foster-Wheeler - FLWT


• Jacobs Engineering - JEC


• Stantec Inc. - SXC


• SNC Lavalin - SNC (on Canada's Toronto Stock Exchange)
  

Well, that's about all for right now - if you're new to the site, feel free to poke around. If you're a regular, thanks for coming by.

JW

The Confused Capitalist

Car makers: Why can't they understand it's all about long-term quality?

I see that the former embattled head of Home Depot, Robert Nardelli, has been named head of newly-private Chrysler Corp.

According to one report, Mr. Nardelli wants to move faster on a turnaround plan announced back in February.

I know this suggestion may come as a stunning revelation to those in the so-called "Big Three" automakers, but given that Mr. Nardelli is new to the industry, I thought I'd let him know what the problem is.

Some 40 years after the "invasion" of the Asian car makers, the reason for the decline in the Big Three market share:

1. isn't because they lack some fine-looking vehicles;



2. isn't because the vehicles cost too much money (because they usually cost less than the "Japanese" vehicles);



3. isn't because they don't win some JD Power "initial quality awards";



4. isn't because the American or Canadian worker is lazy or no good (lots of "Japanese" vehicles are made in the USA and Canada).

No, the reason for the decline isn't any of those reasons - it's because of the crappy long-term quality and reliability issues. People are tired of buying junk. I mean when you hear (as I have) of five, yes, five, automatic transmissions in a Chrysler mini-van (yes, driven by the sedate mini-van crowd) frying before the warranty expires, you've got to ask yourself, why? Why would I ever buy this junk again?

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!

So with the aforementioned in mind, I've prepared a list of the top three tasks for Mr. N over the next five years:

1. Improve the long-term quality and reliability of Chrysler products as much as possible in the next 1-2 years;



2. Seriously improve the long-term quality and reliability of Chrysler products as much as possible in the next 3-4 years;



3. Improve the long-term quality and reliability of Chrysler products to begin truly competing with the best "Asian" vehicles over the next 5-10 years;

There - that's it - the "magic" formula for success - but why do I feel that this is just futile even mentioning it?



JW

The Confused Capitalist

Be vwery careful, vwery, wwery careful ... more on real estate and subprime time

As Elmer Fudd used to say ... be vwery careful ...

About investing in real estate or the subprime mortgage market. You know, just like NASDAQ circa 2000, it took speculators a long time to be convinced that, yes, things were really as bad as they seemed. And that was in the technology stock market, with its hyper-frenetic pace.

Image how long it'll take for *everyone* involved in the real estate market to realize the same. Today, it's just the subprime lenders who are depressed. Tomorrow it's the prime lenders ... and sometime thereafter ... by the real estate speculator ... then to be followed by the real estate investor ... to be finally ... finally ... followed by the deep-pocketed developer/builder.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!

When even all those deep-pocketed guys can think about is surviving, then it's time to buy. And only then.

As I suggested one year ago, real estate debacles of this nature (i.e. free money from Greenspan) will take a long, long, time to boil off - expect market declines in coastal regions to continue for years. In farm country, however, things will be vastly different for several reasons.

Sit tight investors ... patience is now key if you're thinking of sub-prime investing (wait two years), or real estate developer/builder investing (wait three to five years). Yes, it takes a long time for this to unwind and people to become truly depressed about the future ...



JW

The Confused Capitalist

Sub-Prime Mortgage Mess: Did It take a genius?

I'm often amazed at how really smart people can get caught up in the crowd, along with their friends and peers. Caught up in the Extraordinary Popular Delusions and Madness of Crowds, even really smart people have trouble rationalizing their behaviours later, in a way that doesn't sound like they themselves still haven't figured out what happened to them.

In this category then, perhaps I should apply for a job as the head of GE, or perhaps GE Capital, or perhaps as the GE Chief Financial Officer (CFO). GE has recently decided to exit the sub-prime mortgage business, due to its obvious problems and potential for more. In reading one account of the reason they were exiting, GE CFO Keith Sherin said this ...

"In the first quarter we said we were committed to the business and we were. Based on the changes we saw, we made the decision to exit the business. I think it was a smart move."

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!

Back in March 2006 (just after this blog started), I posted on the housing market and the potential for sub-prime loans to wreck havoc on the bottom line, suggesting that ...

"Having seen the tall-headed gnomes in my own financial field previously lend to extreme ratios in the dying days of a real estate upswing, I thought they'd have figured out that lending like that at the end of a long cycle, isn't very good for the bottom line. "

I guess if Keith Sherin didn't realize it wasn't a very good business to be in at the top of a real estate cycle (like about a year-and-half earlier, when they could have sold these assets for a lot more money, instead of taking a charge to get out of the business), then I'm a lot wiser than he is.

Hmmm, I wonder what the pay is in his job? Mr. Immelt let's talk stock options ... how many can I get?




JW

The Confused Capitalist

Two worthy newcomers to the financial bloggers world ...

There's two new blogs out there that I'd like to draw your attention to. Two blogs that might battle for your attention in the future.

The first is a blog written by a TOC, Deborah, from near my area, in rainy Vancouver, BC. She writes a blog called Making Sense of My World.

It's an exceptionally detailed look into the world of mining stocks, primarily, but she occasionally touches on other financial subjects as well. It's clear to any reader, including one like myself who has little understanding of mining stocks, that she has dived in deep enough to figure out "What's Up".

With her, "making sense of my [her] world", she's helped me understand the mining world a bit more. I highly recommend a visit to "Deb's World". See also the new link on my blogroll.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here for additional articles and exclusive content!

The second blog I'd like to draw your attention to is one written by Eric Fox, the Market Prognosticator. Eric recently emailed me and asked me if I'd take a look around his blog. I like someone who asks for what they want, and Eric did that. I was very pleasantly surprised when I read several of his articles, and liked his edgy tone and slant on things. I read several of the articles and enjoyed them thoroughly. An excerpt from ... The Most Terrifying Thing I Have Read in My Life ...

I get an e-mail every morning with a recap of what is going in the market. Most of the time the articles are something I have read somewhere else or I am not interested in them. Today was different. The headline was enticing. It read: How do you pay off your home mortgage in a few years or less? Learn to use hedged ...

The last word was left off but it was not rocket science to guess that the missing word was "futures." Oh this was going to be fun. When I clicked on the link it was even better than I thought. It read: How do you pay off your home mortgage in a few years or less? Learn to use hedged futures with options and arbitrageur strategy.

Well sure why not? There's nothing wrong with 80 million homeowners entering the futures market. This might even solve the sub prime lending mess. People who can't even read a mortgage note trading futures and options.

Eric goes on in the article ... rather amusingly, I might add. I recommend his blog for those looking for a bit of insight and spicy writing.

Find also the link to Eric's blog in my blog roll to the right. Well, hope you all had a safe and enjoyable Independence Day. Bye for now ...



JW

The Confused Capitalist

Raising the Median: Computer Hardware and Software

Image Source: MadAsHellClub.Net

I'm mad as hell and not going to take it any more! (Well, not really, but I am more than a bit disturbed [ask anyone who knows me] :-)

In any case, I've kind of had it with computer hardware and software makers who don't promote better ways to do things and perpetuate the mediocre or inferior.

One obvious example of this is the present keyboard you are probably typing on (just as I am). It's antiquated and inferior in two very obvious ways:

• Firstly, the actual locale of the letters on the QWERTY keyboard layout, is a relatively slow method to type (created to slow typing down, so 18th century typewriters wouldn't jam). Because of this crappy letter layout, Repetitive Strain Injury (RSI) is epidemic among those regularly using keyboards. Additionally, it's a slow way to type, compared to several more modern alternatives, particularly a fairly new one that takes advantage of prior Qwerty training, while minimizing re-training time compared to using a Dvorak keyboard.


• Secondly, the flat keyboard, with its offset letters, also contributes to RSI, to a higher error rate, and was something that was designed for the actual mechanics of a typewriter, never for the human being. That the computer makers chose to perpetuate this too when manufacturing computer keyboards, is even more unbelievable.

So, in relation to item #1 above, a Dvorak layout (which many of you may have heard about) is far superior to the standard Qwerty layout and results in superior speed (the world's fastest typist used a Dvorak layout), and less RSI. However, the problem is, is that almost every key (33 of them) is recast elsewhere on the board, with many also jumping between hands.

This results in a steep time-consuming learning curve, and many people give up because of this (as I did), even though you can easily reconfigure your keyboard through a software add-on (go to Microsoft, here, if interested). This is probably the reason that the Dvorak never caught on - the very steep learning curve.

No, based on this idea though, others have been at work to recast the keyboard letters, using the lessons of Dvorak, but minimizing extraneous key movement from the Qwerty standard, where gains are minimal. In the case of the Colemak layout (moves only 17 keys, and minimal moved to the "other" hand), this results in, reportedly, much smaller learning curve, with similar speed and ergonomic gains to Dvorak.

It is now the third-most popular English language layout, and is gaining converts every day. More information, including a downloadable program to convert your existing keyboard to this superior letter layout is located at Colemak.com. I hope to download and convert to this layout. I'll report out on this from time to time.

(Note: If you're on a blog aggregator, you can visit The Confused Capitalist here or here [http://confusedcapitalist.blogspot.com] for additional articles and exclusive content!)

Keyboard layout comparisons (click to enlarge any of the below):

QWERTY (The old-fashioned, crappy, standard)

DVORAK (A better keyboard, that never caught on, probably in part due to the learning curve - look how many keys not only shift position, but from one hand to the other).

COLEMAK (With some luck, this will become the defacto standard, particularly with young people. Note how many Qwerty positions are retained, because moving them doesn't create significant improvement and moving them needlessly creates more difficulty in learning a new board layout for old-timers, like me)


So if you're looking to be a faster typist, to alleviate your own RSI, and just generally to make the world a better place, head on over the Colemak.com for a free download to covert your keyboard. OK, that's Rant #1 over. Let's move onto Rant #2.

Secondly, the actual keyboard itself sucks! The hardware makers should have corrected the obvious deficiencies in this, once there was no mechanical reason to retain the "offset" configuration. It results in missed keys, too much finger stretching, and incorrect wrist position, among other problems. The Confused Capitalist has been researching this issue however, reading reviews on the net, and believes to have found a superior board.

While some boards split and twist the keyboard (like the Microsoft Ergonomic that I use at work) which solves part of the problem, it still leaves a large portion of the ergonomics unfixed. However, a newer board, called the SmartBoard, solves most of these problems and adds several other key fixes, as well. The SmartBoard is available from datadesktech.com - see image below.

Finally, rant #3, isn't really a rant, but more of an eye opener. Many people use the Microsoft Office programs without believing there's any real alternatives out there. Well, Open Office has been picking up speed lately, and similar in some ways to Linux, converts. It is a free, volunteer-maintained open source program, providing an array of office suite type products. By all accounts on the internet, the latest release is continuing to improve and now rivals most of the Microsoft suite for utility, versatility, sophistication, stability, etc.

In some cases, some of the programs are reported as superior, with the most notable complaints being for the Power Point equivalent "Impress" still not up to the Microsoft standard, while the spreadsheet program "Calc" isn't - for sophisticated users - as good as Excel. However, huge strides have reportedly been made over the prior release. According to my research, many users are reporting that they prefer the Open Office word processor. You can go to OpenOffice.org to download this FREE program. So, even if a couple of the programs aren't quite there yet, it's not hard to think they will be soon.

Oh, and did I mention that Open Office can both properly read and save back into a Microsoft format? So my only question would be - unless you have very sophisticated spreadsheet or presentation needs - why on earth would you spend the bucks to upgrade to the latest Microsoft suite?

By the way, many of you might note the label "Global Warming" below, and wonder how this bloggering possibly ties in with that theme. It's simple really - any improvement in efficiency offers the possibility of turning off the computer sooner, and therefore reduces power consumption. Further, less RSI means fewer trips to the doctor. Ergo, less greenhouse gas emissions.

Secondly, using Open Office, an open source document, means that you don't - perhaps - have to work quite as much, since you don't need to pay for this particular type of product. Ergo, the potential exists for a couple of less trips to work every other year. Times millions of workers = less greenhouse gas emissions.

Perhaps not obvious connections, but ones which can, and I believe, do, exist.

Well, that's it for now - I have all of these links on the right hand side of my blog, under the title "Computer Stuff". I hope you are able to use this to improve your own life - to "raise the median".


JW

The Confused Capitalist

Food Shortages and Food Inflation: Malthusian future?

Image: Food skyscraper of the future?


Although Malthus has long been laughed at by those convinced that technology will solve any problem, in any finite system, one must reach some sort of system limits, as demand for a resource outstrips that method of producing it.

Although it may happen for slightly different reasons than postulated under the Malthusian catastrophe scenario, it appears this is starting to happen with food and will soon be found in a supermarket near you, via food inflation.

There is a confluence of forces that make serious food inflation, at the minimum, particularly likely over the next five to ten years:

Factor number one is the bee die back, and the effect it is likely to have on food prices over the next few years, as yields are curtailed due to a reduction in pollination. One economist figures that this will put over $15 Billion in North American crops at risk, all adding to potential for food inflation.

Factor number two is the growing wealth of emerging markets, and their propensity to emulate a western-style meat-heavy type diet, as wealth grows. This puts increased pressure on grain crops in particular, as it takes anywhere from about 5-20 pounds of grain to produce a single pound of meat. As large populations in China and India move further away from vegetarian or semi-vegetarian type diets, this strains limited global food stores even further, adding to food inflation.

Note: If you're on a blog aggregator, you can visit the Confused Capitalist here or here (http://confusedcapitalist.blogspot.com/) for additional articles and exclusive content!

Factor number three is the changing climate. Scientists have long known that food yields can come under pressure in at least two ways as global temperatures climb. Firstly, at higher temperatures, some plants - despite ample water - either cease production, or lower production. In either case, yields are lowered. Secondly, changing climate results in more extreme weather, including droughts, hurricanes, extreme rainfall etc. Total yields are obviously reduced under those circumstances too. (Alt citation, PDF)

This was recently brought home to me by an Australian cousin, who laments the drought his country has been going through for some time: he tells of kids in some parts of the country now entering high school, who have never seen rain.

Factor number four is the number of lunatic politicians, in their bid to never offend anyone while running for office, avoid telling the truth about ethanol from corn: it's doubtful it actually produces any additional (net) energy after it's energy inputs are calculated, AND it's going to (in fact, already has) further increased food costs.

I watched a shameful 20/20 series where every single presidential candidate at a town-hall type meeting claimed that ethanol was part of the solution, rather than more likely to contribute to an even bigger problem. Whatever happened to a "give 'em hell", Harry Truman style candidate? Are they all too meek, too bland, and too gutless for even one of them to stand up and tell the truth? And the truth is, is that ethanol, bio-diesel, or any other fuel made from food sources is only going to add to food inflation, possibly to serious food inflation.

One article also discusses many of these issues and interestingly points out that China, to feed itself, should be adding a quantity of arable land equal to Maine, every year. Instead, it has lost that amount every year over the past decade. Another article, in the respected Popular Science magazine, discusses these looming food questions.

There are, of course, always those head cases who are convinced that technology will solve any problem. However, increasing technological solutions have coincided with increased energy demands and, in a global warming world, one of these trends most likely has to give.

I read a recent article suggesting that food skyscrapers may be the way of the future - but these won't be coming any time soon and, due to costs, may end up with all those other strange Popular Science ideas that never see the light of day due to cost or technical issues that can't reasonably be overcome.

The Confused Capitalist will provide some practical and investment advice on how to deal with this over the coming while.

More reading sources:

• Vertical Farming Dream


• Deeper Thinking About Serious Issues


• Making realistic interim changes


• For the more personally ambitious


• What changes are really needed & how to go about it

JW

The Confused Capitalist