China and Greece: sound and fury signifying nothing?

Just a couple of weeks ago, you couldn’t look at the news without seeing dire predictions about Greece leaving the European Union or China’s stock market tanking. Now, it seems like these perils have passed and there’s nothing to worry about. That’s unlikely the case.

I’m an optimist by nature, and I tend to think things will work out in the long run. That does not, however, make me a Pollyanna. I don’t think that problems in Greece or China are the end of the world. But, I also think it’s naive to think that such issues were insubstantial and likely to fade with so little hardship.

Greece still can’t pay back its loans, and they are still demonstrating little desire to reform. European lenders still want their loans repaid, and seem unlikely to grant Greece forgiveness for large amounts of debt. In other words, the situation hasn’t really changed, and therefore still requires careful observation.

China’s stock market did not tank because of some bizarre conspiracy. Like all markets that have been artificially pumped up, it must necessarily deflate. Any attempts to defy that natural process are doomed to fail one way or the other. The underlying issue of China’s economy slowing down has not changed. The political and economic consequences are non-trivial and demand watching.

Markets have a natural ebb and flow, just like nature. And, just like nature, those ebbs and flows are largely unpredictable over the short term. That doesn’t mean you can’t see broader themes evolving. It was easy to see that the tech bubble of the late 1990’s would pop, but impossible to predict when. It was easy to see that the housing market of the mid 2000’s would burst, but impossible to predict precisely when.

Greece and China have real problems that will eventually reverberate throughout the global economy. I don’t know precisely when these issues will loom large, but I do know they haven’t been resolved. This is not a good time to ignore those risks.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China and Greece: sound and fury signifying nothing?

It’s all Greek to me

It’s been five years since I’ve written about Greece. Given the market’s current infatuation with that subject, it’s not a bad time to revisit the topic.

To recap: Greece borrowed a lot of money that it can’t currently repay (some would say: can never repay). The Greek government, I’ve read, pays out three euros for every one they take in as tax, so the basic math is unsustainable.

Five years ago, many thought that Greece defaulting would cause a cataclysmic market failure that would lead to a domino effect in multiple markets. At the time, the recency of the 2008-2009 economic collapse made this possibility seem very real and scary. So, Greece was bailed out and given more time to work out its issues.

Greece has not made much headway. When people get used to not paying taxes, they don’t eagerly jump into paying them again. When people get used to receiving government checks, they don’t willingly stop cashing them just because they’ve heard the government doesn’t really have the money. That’s just how most people function.

When a lender lends money, both the lender and the borrower end up with some responsibility. Greece is clearly responsible for paying off its debts. At the same time, the lenders are responsible for lending money to a country that–without massive structural changes–can’t repay those loans. Both Greece and its lender may be indignant, but they’ve both played a part in creating the current crisis.

The basic math says that Greece can’t repay its debts, and that it shouldn’t get additional loans until it reasonably commits to specific measures that will enable it to sustainably pay back its loans. The negotiations between Greece and its lenders that keep failing are about which side has to give up the most.

Greece’s leader was recently elected to make European lenders carry more of the responsibility. He has carried through on his campaign promises by defaulting on loans in order to force a better deal. He has also put Europe’s terms to the test by putting them up for a popular vote on Sunday. I don’t think anyone knows the outcome of that vote.

What is different now from five years ago? There’s been five years for people to alter contracts, make contingency plans, and just get mentally prepared for Greece to default and to potentially leave the euro currency, European Union or the European Community. The damage now wouldn’t be as great as it was five years ago.

The scarier prospect is that Portugal, Spain, Italy, and perhaps even France may end up in the same situation several years from now (they all have structural problems that haven’t been fixed, though none as bad as Greece), and that the European currency/Union/Community could completely come apart. This would not be the end of the world, but it would create a lot of inefficiencies that would slow global growth permanently.

There is always some possibility of a greater market contagion. For example, suppose some bank or government or hedge fund owns a LOT of securities that head south if Greece defaults or dumps Europe. Suppose also that they bought those securities with short term debt and they have to sell other securities to repay their loans, thus forcing down the prices of other, non-Greece related securities. Then, those price declines lead other indebted securities holders to have to sell their securities, etc. You get the picture. I don’t think that is likely, but market contagions have occurred in the past on just such similar lines.

The more important point of Greece’s situation is that governments and people aren’t above the laws of economics. They may not like economic laws, but they can no more be avoided than the laws of physics, chemistry, etc. 

Governments, just like people, can’t spend more money than they take in. 1) Printing money 2) shifting budgets, 3) giving away other people’s money doesn’t create economic growth. Only production creates growth, and governments aren’t productive. The laws of economics will hold up whether anyone likes it or not. The sooner people face that reality, the sooner we can all go back to being productive and growing again.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

It’s all Greek to me

Be careful Mr. Hastings

Reed Hastings and Netflix might want to be careful what they wish for.

Reed Hastings is the fabulously successful founder and CEO of Netflix. Netflix has become a dominant force in streaming video sometimes consuming as much as 60% of all Internet traffic in the U.S. at peak times. They have built up a viewership of around 60 million paid subscribers.

I am a big fan and user of Netflix, and have nothing but good things to say about the company as a customer.

I do, however, have major problems with Mr. Hastings’ use of the government to force his competitors.

Mr. Hastings has used his bully pulpit as CEO of Netflix to oppose the mergers of Comcast (I and my clients own shares of Comcast) with Time Warner Cable, and now AT&T’s proposed merger with DirecTV.

He says that such mergers will harm customers when he is really just feathering his and Netflix’s bed. 

He doesn’t want his competitors charging him higher rates, so he is using the government to do what he can’t do in fair competition. This is kind of like asking a referee to change the rules of the game to benefit your team.

Although he has already succeeded in stopping the Comcast and Time Warner Cable merger, and may succeed with the AT&T and DirecTV merger, he may want to consider what will happen when his competitors enlist the government’s help to deal with his dominant position.

After all, his complaint against Comcast was that–if the merger went through–they’d have 60% market share in broadband to the home. Perhaps he should consider his own market share and how that may play out over time.

The problem with getting the government to intervene for you is that as your success grows, you too become a target. The same is true in paying protection money to the mafia–it doesn’t work in the long run.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Be careful Mr. Hastings

Income inequality…tax inequality

Income inequality has become a big political topic recently. Unfortunately, the debate is filled with more emotions than facts.

What shouldn’t be surprising is that those who make more also pay more in taxes–a lot more (especially with our progressive tax system).

Anyone who wants to understand the income inequality debate should probably become acquainted with some of the facts about how much tax inequality comes with income inequality.

A recent article in the Wall Street Journal (subscription required), with data from the Tax Policy Center, highlights this issue.

The bottom 20% in the U.S. makes $0 to $24,200 a year, earns 4.5% of total U.S. income, and gets paid 2.2% from income tax.  

The next 20% makes $24,200 to $47,300, earning 9.3% of U.S. income, and gets paid 1% from income tax.

The middle 20% makes $47,300 to $79,500 a year, earns 14.8% of total U.S. income and pays 5.9% of total income tax.

The next 20% makes $79,500 to $134,300, earning 20% of total U.S. income and paying 13.4% of total income tax.

The top 20% makes more than $134,300 a year, earns 51.3% of total U.S. income and pays 83.9% of the total income tax.

Breaking down the top 20%, the first 10% (those making the top 80% to 90% of income) makes $134,300 to $180,500, earns 13.1% of U.S. income and pays 10.8% of the income tax.

The next 5% (top 90% to 95%) makes $180,500 to $261,500 a year, earning 9% of all income, and pays 9.1% of the income tax.

The next 4% (top 95% to 99%) makes $261,500 to $615,000, earns 12.1% of all U.S. income, and pays 18.3% of income tax.

The top 1% makes over $615,000, earning 17.1% of all income and paying 45.7% of all income tax.

Yes, income in the U.S. is unequal, and that is because native ability, work ethic, and knowledge are unequal. 

It should be acknowledged, too, that those who make so much also pay MUCH more than those who earn less.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Income inequality…tax inequality

Frugality for Fortune

When most think of building a fortune, they think of starting a business, taking a big gamble, or getting wildly lucky.

The reality is that building a fortune is easily accessible to anyone willing to live within their means, save diligently, and invest wisely.

The Millionaire Next Door illustrates this point well. So did a recent article in the Wall Street Journal (subscription required).

Ronald Read recently passes away at the age of 92 with $8 million in investments and saving. Did he start a business, take a big gamble or get wildly lucky? Nope.

He “displayed remarkable frugality and patience–which gave him many years of compounded growth.” “He lived modestly, working as a maintenance worker and janitor at a J.C. Penney store after a long stint at a service station….”

“Those who knew him talk of how he at times used safety pins to hold his coat together and sometimes parked his 2007 Toyota Yaris far from where he was going to avoid having to feed the parking meter.”

This isn’t quite the 1% popularly portrayed in the media. This was a normal guy who worked, saved and invested.

“Mr. Read owned at least 95 stocks at the time of his death, many of which he had held for years, if not decades.” Not really day trading.

His holdings were “spread across a variety of sectors, including railroads, utility companies, banks, health care, telecom and consumer products. He avoided technology stocks.” He invested in things he understood after doing his own research.

“Friends say he typically bought shares of companies he was familiar with and those that paid hefty dividends. When dividend checks came in the mail, he plowed the money back into more shares….”

No six-figure income. No internet start-up. Just living within his means, saving consistently, investing after doing his homework. Being patient, being frugal, thinking long term.

Financial success doesn’t require lots of luck or risk taking. Just simple strategies implemented consistently. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Frugality for Fortune

Net neutrality and Title II regulation of broadband

The Federal Communications Commission (FCC) voted 3-2 to regulate broadband internet yesterday (under Title II of the Communications Act of 1934). This move is being heralded as a big victory for the little guy. In reality, it is the victory of those with more political influence over those with less. In contrast to the way it is being portrayed, I see this as a loss for the little guy.

(Full disclosure: I and my clients own shares in companies that provide broadband internet).

Title II regulation gives the government sweeping powers to regulate broadband internet, which is the way people access the internet through their cable, copper or wireless connection. This is being portrayed as a benefit to consumers: so that there is no interference between the providers of online content and the users who want to see that content (a concept frequently referred to as net neutrality).

The fear has been that cable, DSL and cellphone companies would throttle and restrict access to the web in order to extract “a pound of flesh” from users and content providers. In this view, access to the internet is a public good granted by the government through franchise rights and wireless spectrum. As such, the government must intervene to protect users and content providers from mean-spirited content distributors

Content distributors have a right to their work and investment just as much as content producers and users. Buying cable franchises (that aren’t exclusive) and spectrum doesn’t bring broadband to our doors.  It takes massive investment in cables, people, equipment, digging, stringing poles, writing software, etc.). The stock and bond holders of those companies (which are mostly little guys) deserve a return on their investment just like everyone else. They should be able to determine how their assets are utilized as long as they aren’t violating anyone else’s rights. So far, they haven’t.

It is not content users that are crying foul and asking for government interference (except, perhaps, those selling pirated movies that don’t want to have to pay for their massive bandwidth usage). Instead it is content providers who don’t want to have to pay to access broadband distribution. It is Netflix and other broadband hogs which sometimes occupy 60% of broadband at a time that are crying foul and want government intervention, not users on the whole. 

This is a fight between big guys and big guys, not little guys, and the ones who can get the government on their side wins (the profits margins of content providers asking for Title II regulation are much higher than the content distributors, perhaps this is why they can gain more influence).

And, here, we can go back to a historical analog. The Federal Trade Commission (FTC) was created 101 years ago, partly to regulate railroads who were being accused of charging unfair rates. The complaints came mostly from businesses that didn’t want to have to pay so much for railroad service, not from consumers (sound familiar). 

The result was a labyrinthine regulatory structure that strangled the railroad industry in the United States for over 60 years. When railroads found it almost impossible to charge rates to justify investment in their railroad systems, the systems went into chronic disrepair. The railroad industry limped along for years under-investing in their tracks, engines and freight cars, thus killing passenger travel (which survives today only with government subsidies and regulation that forces railroad freight companies to let passenger trains use their track). Only recently, since the Staggers Act of 1980, has the railroad industry recovered, and one of the biggest reasons is that they can charge fees that justify investment.

Turning back to broadband, I believe the same thing will happen. At first, the regulation will be used as a light touch to nudge broadband providers to be “more fair” to users who complain loudest, or at least who have the most political influence. Over time, though, it will throttle investment in the industry, hurting the very content providers and users it is supposed to help (every phone and cable company I follow has said they will reduce their investment in broadband distribution if they can’t generate sufficient return).

To raise capital and build an industry, businesses need to be able to make money. As long as no one’s rights are being violated, the market best decides where assets should go and at what prices. In the absence of that productive situation, investment and progress will stagnate. In the long run, the little guy will be hurt most (but he won’t realize this, because he’ll never know what he could have had).

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Net neutrality and Title II regulation of broadband

Stock market up 60% since 2007 peak

Building wealth over time requires the fortitude to stick to your plan.

Colorado Spring’s own Allan Roth made this point nicely in a recent Wall Street Journal article. His basic point is that even if you had been unlucky enough to buy at the stock market peak of 2007, your wealth would still be 60% higher now if you had stuck with it.

The problem is that so few stick with it.

Yes, the market went down over 50% from that 2007 peak. But, those losses were temporary. The U.S. businesses underlying the market rebounded and are doing well.

Nothing in life is free. The price of generating good long term investment returns is having the courage to stick to a good plan. 

That means you have to be able to ride the market up and down without getting so that scared you sell at the bottom or so euphoric that you don’t adjust your portfolio at the top.

Becoming wealthy is not rocket science. Spend 80% of you income, invest the other 20% in the highest performing asset class over time–stocks–and have the intestinal fortitude to stick to that plan over time.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Stock market up 60% since 2007 peak

Adapting as an investor

I remember well how much I loved to program computers. As a cadet at the Air Force Academy taking lots of astronautical engineering courses, I had to do a lot of computer programming.  These projects were very complex, requiring precise calculations (to 8 significant digits) of the velocity and position of satellites, antenna pointing angles, terrestrial positions, etc. They were done on 286 Zenith computers without hard-drives, so some programs could rake as long as 24 hours to run.

I love the process, though. No matter how difficult the problem, I could always solve it. It was like a big puzzle: figure out what part of the program went askew, make changes to that one part and test it repeatedly, and keep doing that until you got it right. Then move on to the next part and repeat until you got it all solved. My classmates were frequently amazed that I would have the projects done weeks in advance. I just loved the process.

Investing doesn’t work so easily. The difference is the noisy feedback loop. Orbital mechanics is like clockwork. You know the starting situation, you know the physics, so when something goes off track it is easy to see that it’s wrong, and it is easy to figure out where to jump in and fix it.

With investing, the data is much more noisy. By noisy, I mean there are lots of false signals that things are going well when they won’t in the long run, and that they are going poorly when they will go well in the long run. 

In other words, when you make a change to your investing process, it can take years, perhaps even decades to see if you really have it right. That’s not the happy feedback loop of computer programming with instant and clear feedback.

But, that is the nature of the beast. When you see your results aren’t doing what you expect, you need to make changes to adapt, and then wait another couple of years to see how that worked.

The process is the same as it is with computer programming, but the signal is very noisy, meaning you don’t know if things have actually gone wrong or not, and the feedback loop takes years instead of minutes to complete. 

I have to admit, I still love to solve the puzzle. Just like with computer programming, I’m as committed and convinced that I can get it right.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Adapting as an investor

The Lessons Of Oil

Not many outside the investing business have heard of Howard Marks. He is a very successful money manager at Oaktree Capital with a reputation built mostly around distressed debt investing.  

He also writes very well and publishes Memos that I eagerly read.

His latest is on the fall in the price of oil and what lessons we can learn from it.

I highly recommend it to anyone who wants clear thinking on the subject.

If you don’t want to read it, here are some quick highlights:

“…what ‘everyone knows’ is usually unhelpful at best and wrong at worst.”

“Not only did the investing herd have the outlook for rates all wrong, but was uniformly inquiring about the wrong thing.”

“Asset prices are often set to allow for the risks people are aware of.  It’s the ones they haven’t thought of that can knock the market for a loop.”

“Forecasters usually stick too close to the current level, and on those rare occasions when they call for change, they often underestimate the potential magnitude.”

 “This is an example of how hard it can be to appropriately factor all of the relevant considerations into complex real-world analysis.”

“Most people easily grasp the immediate impact of developments, but few understand the ‘second-order’ consequences…as well as the third and fourth.”

“…it’s hard for most people to understand the self-correcting aspects of economic events.”

“If you think markets are logical and investors are objective and unemotional, you’re in for a lot of surprises.”

“A well-known quote from economist Rudiger Dornbusch goes as follows: ‘In economics things take longer to happen than you think they will, and then they happen faster than you thought they could.'”

“The key lesson here may be that cartels and other anti-market mechanisms can’t hold forever.”

“…it’s hard to analytically put a price on an asset that doesn’t produce income.” 


Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The Lessons Of Oil

How to make a fortune

The Forbes 400 list of richest Americans came out recently (you can see it here).

I enjoy looking through the list each year (and have for 20) to better understand how people become wealthy. We are not talking about the mass affluent, the affluent, high net worth, or even ultra high net worth, here. We are talking about billionaires. The highest on the list is at $81 billion and the lowest is at $1.55 billion. These people haven’t just become wealthy, they have become fabulously so. How?

That’s the question I ask myself each year, and this year I decided to keep track.

I wasn’t interested in finding out how many inherited wealth. Inheritance does not create wealth. With this in mind, I kept track of how the Forbes 400 made their fortunes.

One category is entrepreneurship. These are people who come up with an idea and then put it to work by starting their own company. The Forbes 400 is dominated by these folks at 52% of the list. Some did it through technology, others through retail, some with restaurants, some with medical devices and pharmaceutical products. These people create the new products and services we all enjoy. They had to be smart and hard working to succeed, but also had some good luck. Think Bill Gates, Larry Ellison, Sam Walton, Michael Bloomberg, Mark Zuckerberg, Larry Page and Sergey Brin. Not only do the dominate the list as a whole, they dominate the highest rungs of the list.

Next are the business fortunes, clocking in at 20%. These are people who instead of starting companies, either worked at businesses or bought businesses from others and put themselves in charge. Looking over the list, I see that they frequently fix broken businesses or make okay businesses great. Think Steve Ballmer at Microsoft, the Koch brothers, Rupert Murdoch, Richard Kinder, George Kaiser and Meg Whitman.

Next are the investing fortunes, coming in at 19%. These are people who don’t start or run businesses, per se, but invest others and their own in such businesses. They may influence the businesses, but they don’t run them. In some cases, they are completely separate from the business. This can be done through a holding company, with a hedge fund, through private equity, or running money through mutual funds. Think Warren Buffett, Carl Icahn, George Soros, Len Blavatnik, Ray Dalio, Ron Perelman, John Paulson and James Simons. 

Next are the real estate fortunes, coming in at 9%. These fortunes were built by buying real estate–usually with leverage–and rolling the dollars made back into more real estate. These fortunes are high risk/high reward because of the leverage usually required, but also require smart business moves and an understanding of where and how real estate will succeed. Many Americans, I think, over-estimate how successful this strategy is. The list includes names like Donald Bren, Andrew Beal, Stephen Ross, Richard LeFrakand and Leonard Stern.

I was surprised to see there is a lawyer on the list: 1. So, being a lawyer comes in at 0.3%. Way to go Joe Jamail: The King of Torts.

There you have it. Entrepreneurs top the list. You can make a massive fortune by finding an unmet market need and meeting it through hard work, long hours, and a good piece of luck. Or, you can be a successful businessperson joining the right company at the right time or by fixing broken or sub-par businesses. Or, you can invest other people’s money through lots of research and a knack for understanding when markets become irrational. Or, you buy and sell real estate with a lot of debt, some good luck, and a keen sense of location, location, location.

Or, you can be the King of Torts.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

How to make a fortune