View From a Height

New Company

Athena Investment Services is a new company that I've been doing some research and web development for over the last couple of months. They're trying to reshape the way mutual funds are categorized and evaluated, and we're starting off by challenging the traditional Morningstar Style Boxes.

Go take a look, download the Style Grid paper, and then go back as the thing develops.

Light Blogging Today

Lots of work and catching up to do. I have reports from Friday and Grover Norquist's fundraising visit last night.

Satiate your blog-reading Jones with this week's Carnival of the Capitalists, for the moment.

Morningstar's Style Boxes- II

One of the claims that Morningstar makes is that its style boxes have a lower correlation that their competitors'. That's true, but it depends strongly on what time period you use.

Using Morningstar's own numbers for annual returns, years 2000-2004, the average correlation among the style boxes is 0.927. However, if you include the years 1997-1999 in the calculation, the correlation drops to 0.606. Holding Size constant, the average correlation drops from 0.927 to 0.677. Holding VG constant, it drops from 0.955 to 0.756..

Why?

Well, for one reason, the years 1998 and 1999 provided a huge differentiation between value and growth (mostly Internet) stocks, and between small (mostly Internet) and large stocks.

But I think the more important reason is that Morningstar introduced their new style boxes in 2002. That meant that they were researching the algorithm as far back as 2000, and all they had to use was restrospective data. So it's no surprise that any formula would, like an Italian tank, work better in reverse.

I don't believe Morningstar is guilty of anything here other than marketing. But the fact is, the correlations among their style boxes are probably a lot higher than they would lead you to believe.

Here's the data, for those who want to check.

Plug-In Car Runs for Minutes

So you've been waiting for your electric car? The car that's better than a Prius? The car you can just plug in at night and drive all day? The car that doesn't even use oil or even any fossil fuels?

Wait on.

AP and Denver Post salivating aside, energy independence at a reasonable price is not just around the corner.

Politicians and automakers say a car that can reduce greenhouse gases and free America from its reliance on foreign oil is years or even decades away.

Ron Gremban says such a car is parked in his garage.

It looks like a typical Toyota Prius hybrid, but in the trunk sits an 80- miles-per-gallon secret: a stack of 18 brick-sized batteries that boosts the car's high mileage with an extra electrical charge so it can burn even less fuel.

Gremban, an electrical engineer and committed environmentalist, spent several months and $3,000 tinkering with his car.

Like all hybrids, his Prius increases fuel efficiency by harnessing small amounts of electricity generated during braking and coasting. The extra batteries let him store extra power by plugging the car into a wall outlet at his home in this San Francisco suburb, all for about a quarter.

Ah, the greedy automakers and the lazy politicians in their hip pockets. Or maybe it's the other way around.

They have support not only from environmentalists but also from conservative foreign-policy hawks who insist that Americans fuel terrorism through their gas-guzzling.

See? If even conservative foreign-policy hawks are in favor of it, there can't be any arguments against it, can there? Never mind that "energy independence" is a bipartisan chimera that politicians have been chasing for decades. Never mind that we never pay the Saudis directly for oil, anyway. Never mind that lowering demand lowers the price, and since Saudi Arabia can produce oil by looking at the sand, the first oil wells to go out of business will be domestic ones. Or that oil gets used for a million things other than driving your Prius around town. Like diesel for hauling the Prius to the dealership. Doesn't matter.

But the problems with this report are even more fundamental.

The extra batteries let Gremban drive for 20 miles with a 50- 50 mix of gas and electricity. Even after the car runs out of power from the batteries and switches to the standard hybrid mode, it gets the typical Prius fuel efficiency of around 60 mpg. As long as Gremban doesn't drive too far in a day, he says, he gets 80 mpg.

So, how much does Gremban save every day? Let's do the numbers (cue "Stormy Weather.")

Since a Prius running on 100% gas gets 60 mpg, that means that first 20 miles normally costs about a third of a gallon. Since he's only using half the gas, he saves about 1/6 of a gallon of gas. Being generous, at $3.00 a gallon, that's about 50 cents a day. Minus the 25 cents he spends charging up. So for his work, Gremban is saving about 25 cents a day. But that's all. He doesn't save more by driving farther, because the extra batteries are run down. He extends his car's range by about 10 miles above a manufacturer's spec of about 650 miles.

At that rate, given that he's already put $3000 into the car, he'd better plan on its being his last if he wants to earn back his investment. And that's without using present value on the savings.

There are other people at work on this, though. People who want to turn this into a business:

Southern California-based Energy CS has converted two Priuses to get up to 230 mpg by using powerful lithium ion batteries. It is forming a new company, EDrive Systems, that will convert hybrids to plug-ins for about $12,000 starting next year.

The AP is making claims for EDrive that even EDrive doesn't make. Look at their FAQ:

Q3: ...The result is EV driving and electrically boosted gasoline driving for the first 50 to 60 miles with a gasoline efficiency of 100 to 150mpg. After the 50-60 mile 'boosted' range, the vehicle performs just like a standard Prius until it is plugged in again.

Q7: Can I really get over 200mpg with EDrive on my Prius?
A: Yes, but it requires low speeds (55mph freeway) and mild acceleration in city driving. Most Prius EDrive users will likely get closer to 100mpg.

So EDrive is being more honest that the AP or the Post that ran this turkey. For 60 miles, barely enough to get you from your home in Warrenton to your desk job for the EPA in Washington, DC, you can get about 120 mpg. That saves you about half a gallon a day, or about $1.25. Minus the $.25 for charging. At a $12K conversion cost, you, too had better be hoping for a VRE extension.

It's no good saying you can also charge the car at work or at the mall, and save going home, too. EDrive admits that the appeal is that electricity is cheaper at night. There's a reason for that, too. The last thing the electric companies want is more stress on the grid during peak hours. And like most arbitrage opportunities, this one will close at least a little if half the country has its cars plugged in at night.

The article closes with a dig at actual creative thinking:

University of California-Davis engineering professor Andy Frank, who has built a plug-in hybrid that gets 250 mpg, said that although automakers' promise of hydrogen-powered vehicles has been hailed by President Bush, hydrogen's backers admit the cars won't be widely available for years and would require new fueling stations.

Right now, batteries don't provide enough range to actually buy you anything. When and it the billions of dollars we've poured into battery technology over the last couple of decades pays off, you'll still need new stations, either to charge up or to exchange batteries.

Defenders will point to these two paragraphs in the middle of the article:

But Toyota officials who initially frowned on people altering their cars now say they may be able to learn from them.

"They're like the hot-rodders of yesterday who did everything to soup up their cars," said Cindy Knight, a Toyota spokeswoman. "Maybe the hot-rodders of tomorrow are the people who want to get in there and see what they can do about increasing fuel economy."

Personally, I think Toyota is being polite. It's not like anyone's actually throwing real money at this problem. But right now, there's a limit as to how much electricity you can pack into a given volume. And throwing extra car batteries into the trunk next to the spare tire isn't going to solve it.

The AP and the Post are guilty of raising unrealistic expectations, creating false bogeymen, at the price of ignoring honest efforts by people who have the most to gain by finding an answer.

Markets That Aren't Always so Wise

People who've read my review know I'm a big fan of James Surowiecki's The Wisdom of Crowds. That said, I think his faith in the market's pricing mechanism may be a little overstated. And not just because it seems prone to frequent, er, corrections. Surowiekci himself notes the difficulty of pricing in long-term company performance. What he doesn't note is the way that analysts get around that problem, and how it violates of one his conditions for collective wisdom - independence.

If you're like most people, you probably think that analysts - even Janus-type "smartest-guy-in-the-world" analysts who dive into tunnels and count heads at restaurants come up with their estimates in sort of an isolated, cloistered, ivory-tower-with-oak-paneled-walls sort of way.

Not.

Most fundamdental analysts (and most analysts are fundamentalists) use one of two methods to value a stock: ratios or discounted cash flows. I won't get into a long discussion here, but basically discounted cash flows estimate the expected free cash flow - how much money the firm actually makes - and tells you what that's worth to you now.

So far, so good. Except that nobody acutally relies solely on those numbers. Ratios are things like Price-to-Earnings, Price-to-Sales, Price-to-Free Cash Flow; that sort of thing. Many people who use a discounted cash flow analysis also use a ratio analysis to estimate the value of the "out" years, the years past their 5-year model. And even those who don't, usually use some sort of comparison to industry ratios to make sure they're still in the same ball park, even if it is a little hard to see home plate from here.

Do you see the problem? Ratio analysis already includes the price of the stock. There's no independence here. Analysts - fundamental analysts, anyway - are alway all looking around at each other to make sure they're going in the same direction, which may still be right over a cliff. The technical term for this is "herding," an analysts do it all the time.

Now, you may say that analysts don't set the market price, the market does. And you'd be right. To a point. But analysts are extremely influential in making markets, especially when they act in groups. Why else do Schwab and other public sources of research report analysts estimates? And remember, this sort of modeling is exactly what M&A and investment bankers do to set purchase prices and IPO levels.

There's really no way out of it. Trying to forecast earnings past five years in advance is truly folly, and most analysts, given enough sodium pentathol, with readily admit to that. Still, the company does have expected earnings, and thus value, past that point, and they must be taken into account. The only way to do this is to assume that the market is basically right, and tweak the numbers until they look realistic.

But this may also help account for sudden changes in individual stocks on seemingly minor news, missing earnings by a penny out of 60 cents, or what-not. Not only is everyone re-evaluating their estimates on their own terms, they're also re-evaluating them on everyone else's terms, too.

Which means that a market's wisdom may not be so collective, after all.

The AP (and the Denver Post) Do Layoffs

Well, those of who work at Janus (although not for Janus) knew it was coming. In the wake of disappointing quarterlies, the company cut 40 jobs yesterday, mostly in administration and operations. While the Rocky found plenty of space to describe what happened at one of Denver's major employers, the Post could only manage a couple of hundred words from the AP.

Tucked into the report was this somewhat snarky paragraph:

[COO] Miller is the only executive among those whose jobs are being cut, according to Peterson. The others are being drawn mostly from the ranks of the company's back office in Denver and include employees in administrative and operations roles.

Ah, the bigwigs protecting their own while the little guy gets the shaft.

Except that the Rocky reports that:

In another change, Janus said that Beery had volunteered to waive the renewal of her employment contract, which would have given her a payment of three times her base salary and bonus, plus accelerated vesting of restricted stock and options, if she lost her job or had her duties changed.

I also happen to know from personal discussions that at least two directors lost their jobs, as well.

It's miserable to get fired, especially when you've just been doing your job. But the Rocky found the space to give a full picture, while the Post left the impression that the 7th floor was taking it all out on the little guy.

The Compleat Electronic Subversive

As any Neal Stephenson fan knows, it's an arms race between the encryptors and the decryptors. Still, this looks like the kind of thing that any aspiring terrorist operative - or Chinese protest organizer - would want to have.

Stealthsurfer II is a little USB device that looks like one of those Jumpdrives, but acts as a shunt for all your Internet traffic. Even browsers with very small caches still write to disk, and those files are more or less permanent. Arthur Anderson should also have taken hammer to all of their Enron hard drives. The Stealthsurfer intercepts email, web browsing, and FTP traffic, and encrypts it using ES3. It's apparently versatile and easy to use.

Why would this be useful? Well, think of the number of intelligence coups we've had when we caught al-Qaeda guys parading around with their laptops. Using the Stealthsurfer, much of this content would never have hit the hard drive. Captured, they could either impersonate drug mule or just toss the little capsule away. Someone could use the Net for operational traffic, and if they weren't under surveillance, searching their laptop wouldn't do intelligence agents or federal prosecutors any good.

Another feature lets you spoof your IP address, making it seem as though your traffic is originating from a computer thousands of miles away. Handy little tool for the terrorist on the go.

It appears that the service reroutes your traffic through their servers, 128-bit encrypted, so the host website your accessing thinks that Anonymizer is the client. Anonymizer claims to cooperate with law enforcement, but if the transmitted information is already encrypted or hidden, they might never know their service was being used this way. And since they also claim they don't keep any of the traffic, the trail might well stop at their servers.

Now the tool does have limitations. Chinese dissidents or protest organizers wouldn't exactly be able to parade into an Internet cafe and cover their tracks. There's a login screen, a popup window, and some other give-aways. Also, the ChiComs are in the nasty little habit of blocking internet sites and monitoring traffic, so this kind of thing is likely to attract the attention of that little white van parked across the street.

So, take an electronic one-time pad that tell me where to look for my next instructions, a host site that has nothing but an innocuous-looking JPEG with the instructions embedded in it, a hand-held GPS for setting up remote drops and meetings. Add plausible deniability to my laptop and even my physical location, and I'd say we've got a little problem here, 99.

Carnival of the Capitalists

	Welcome to this week's Carnival, sponsored by MarketingLinx, the best marketing site on the web, as determined by you. Contribute a link today to get your reward! This week's contributions were fantastic. Hosting really is a different experience from reading, and I'd highly recommend it to regular readers. I haven't included any of my own postings this week, but feel free to look around. Some of you may have received multiple pings while I was building the posting, and I apologize for any inconvenience. And so, without further ado, on to the Fair:
	Editor's Choice Sportsbiz thinks that Nike may be hearing footsteps, as Adidas buys Reebok. Kathy Hutchins at the Reform Club comments on the economics of Pfizer, er, Willy Wonka and his Chocolate Factory. Soccer Dad notes another failed attempt to repeal the laws of supply and demand. Political Calculations has some eye-popping historical charts for the S&P 500, and links to more like it. Photon Courier has a great customer service story, and some ideas on how more companies can encourage this sort of thing. Will Pate offers a reminder to keep an open mind about new experiences, while Big Picture, Small Office warns against creeping, or in this case, stampeding complacency. The Big Picture looks back on last year's holiday tech purchases, and draws some conclusions. Crossroad Dispatches doesn't read blogs for news, but for ideas. That right there is a pretty good idea.
	Accounting Roth & Company has some very useful news about some SEC rules changes regarding insider options. Corporate Strategy Techtrader doesn't like the way Macrovision's going, and thinks maybe it's time for two divisions to go their separate ways. BusinessWorks has some critical questions for would-be entrepreneurs. We've all forgotten about them at some point. Personal Finance Monty Loree wants people to make up their minds about how rich they really want to be. Free Money Finance suggests that maybe having the latest designer pet won't help you get rich. Multiple Mentality considers spending - even inconspicuous consumption - as the SOMA of our age. In Cash Flow We Trust explains that frugal doesn't mean cheap, and it may keep you out of purgatory. Sound Money Tips shows that money management isn't just for adults. All Things Financial shows you how much you'll need for college - assuming that Soccer Dad is right.
	Economics Smart Money Daily examines the application of retail markets to help solve environmental problems, and Half Sigma has related thoughts on conservation and recycling. Interim Thoughts welcomes medical tourists to India. You don't see so much of that in China, yet... Econbrowser has some critical words for the way the Conference Board is handling the yield curve. Speaking of economies, WILLisms has a bar graph that should send Euro-boosters scurrying for the bar. Finance & Investing Consumerism Commentary thinks that the Golden Ratio may be a useful technical analysis tool. Real Returns claims that large companies are sufficiently diversified so that top-heavy large-cap indices don't bother him. This could also go under economics, but the Scrivener thinks that now may be the time to bet against oil.
	Management Steve Pavlina finds that motivational tapes really do help manage your own emotional state, and make you more productive, too. Gautam Ghosh offers some pointers on how to make training last beyond the post-classroom drinks. Ales Rarus finds himself reluctantly defending WalMart from unfair accusations. Chief Skipper lets leaders know that it's ok to be a little lonely, but they have to know how to handle it. Talking Story has some very sound advice for leaders on how to grow more leaders. Maybe you'll be less lonely that way. Interested-Participant is unconvinced by a Tulane study showing that women who flirt at work are only hurting themselves.
	Marketing Wordlab tells you what Maybach is and why they named their new product the Fulda Maybach Exelero. Strategic Marketing Montreal tells a story of harnessing the Internet to help debug his blog. Drakeview tells marketers and retailers to brace for the Gen-Y onslaught. The Egoist notes that video games are starting to branch out from Grand Theft Auto. I personally thought the ad for that game in the Chassidic section of Brooklyn wasn't the best-targeted placement. The Skwib lampoons some ads that were more than just poorly-placed. Marketing eYe, whose blog includes a fine subscription form, instructs on how best to market through newsletters.
	Blogging Worker Bees Blog has some post-Blogher ideas, and warns that networking and connections build traffic as much as good writing does. (Hey, why do you think I'm hosting this thing?) Lip-Sticking offers some post-Blogher inspiration as well, valuable for all bloggers. Blog Business World has a terrific FAQ about business blogging for non-bloggers, and those who want to get started. Ripples... discusses how his traffic has benefitted from placing Blogads.
	Policy Gongol looks at Federal Government ROI, and thinks maybe we could be putting our money someplace better. Warren Meyer of Coyote Blog wants to know why privacy rights seem contained to abortion, and wants them expanded. Elie Rosenfeld would like a little more honesty from PBS (and who among us wouldn't?), this time concerning their fundraising. Chocolate and Gold Coins wants to cut to the chase and allow local phone competition, already. The Enterprise System Speculator follows more cases of SOX compliance run completely amok, and makes a plea for common sense. Mover Mike names a few companies that could be hurt if the mainline churches continue to divest from Israel. Ethics Health Business Blog's blood pressure is up over conflicts of interest in both the Journal and Sociey of Hypertension. Catallarchy explores polygamy. Not personally, mind you, just theoretically.

Oil: Canary in a Coal Mine?

I'm now trying to get out of the web development biz, and into equity analysis, and interviewers are going to want to see work product. I don't actually have much work product, but one of the analyst positions I've applied for is an oil equity analyst. I'm sure once I'm finished writing them up, I'll post them over here, but for the moments, I'm following the industry news pretty closely.

Then, I noticed the Washington Post had an article about the creeping takeover of oil reserves by governments:

Peter J. Robertson, vice chairman of Chevron, worries about the increasing dominance of national oil firms. Given that they already control more than three-quarters of the world's oil reserves, "if governments can come along and gobble up the rest of it at a percent or 2 percent at a time, pretty soon the commercial business looks pretty thin," Robertson said.

You'll notice, by the way, that every country with nationalized oil companies and oil reserves is a prosperous, peaceful example of the democratic rule of law.

I can't see any way this is good - for the countries, where it will just perpetuate corruption; for the independent companies, who will have to pay higher prices and will likely face a future of endless technology transfer; for the world economy, which will pay to subsidize Hugo Chavez's not-so-excellent adventures.

International oil companies and national companies, while sometimes rivals, often work together. In many cases, national oil companies lack the money, technology or managerial skill needed to develop big projects and seek to work with the bigger firms.

But some national oil companies have gained enough know-how to begin closing that gap. According to PFC data, more deals are being made between national oil companies, allowing one to operate in another's home country -- leaving the international firms out altogether.

Time to go back and re-check those growth estimates...

Posted by joshuasharf at 12:55 PM | TrackBack

China Subsidizing Its Enemies

Larry Kudlow details the budding Pacific Anglospheric Alliance (PacAngloPac?) between the US and India, especially the business aspects. I think he's ignoring a possible stock market bubble there, but leave that aside.

He points out that India may be on the verge of relaxing foreign direct investment restrictions, and that the US would probably be the main beneficiary of that.

Now, for all of you who don't like economic globalization so much, consider this. US corporations, flush with cash, need places to invest. Much of their cash is coming from low interest rates, subsidized by Chinese investors. Or by Chinese FDI.

If we turn around and invest heavily in India, that means that, essentially, Chinese money is going into India.

How long will it be before we start seeing articles asking why, oh why, the Chinese are subsidizing the development of their enemies?

Heh.

New CFA Blog Posting

The CFA blog's actually getting a few hits, so it deserves a new posting. Or two.

The (Mis)behavior of Markets

According to Modern Portfolio Theory, the basis for most of modern stock market analysis, the crash of October 1987 shouldn't have happened in our lifetimes. In fact, it shouldn't have happened in the lifetime of the country. It should have happened, perhaps, once in the lifetime of the universe. It was just our good fortune to have lived through it. Now we can relax.

In fact, even as Robert Merton and Myron Scholes were accepting the Nobel Prize for their contributions, the markets were preparing to given the Royal Swedish Academy second thoughts.

So what went wrong? Why did MPT fail so catastrophically? What assumptions failed? Why do academics and researchers continue to base their research on those assumptions? And is there anything out there that might be better?

Benoit Mandelbrot, Father of Fractals, Creator of Chaos Theory, Maker of the Mandelbrot Set, has some ideas, and The (Mis)Behavior of Markets tries to bring them to the public.

I fell in love with fractals and chaos theory in college, when both it and I were young. I didn't pursue a career in physics, and left them behind, I thought for good. Ah, but life is strange, and just a couple of years before I decided to turn towards finance, so did Mandelbrot and fractals, and there there are, my old friends, waving me over to the table for drinks.

Actually Mandelbrot started out as a market analyst, but got sidetracked for a couple of decades, and is now turning his attention back to the problem that got him started: why historical cotton prices don't look anything like a normal distribution.

Mandelbrot spends the first half of the book explaining the roots of Modern Portfolio Theory, and why the simplifying assumptions simplify it out of relevance to the real world. He doesn't suffer fools gladly, and while he doesn't actually come out and call anyone a fool, he does let the read draw his own conclusions.

I've covered the problems with MPT is previous reviews and comments, so I'll just touch on them here. MPT is based on the early 20th Century work by M. Bachelier, who took his cue from Brownian motion, the random motion of particles suspended in water. That motion is normally distributed. Well, if dust motes, why not stock prices? Bachelier posited that stock prices moved some small amount each day, that the movement was normally distributed, and that there was no memory from one day to the next.

Why normally distributed? Well, like the guy who loses his keys over there in the dark, but looks for them over here under the streetlamp because the light's better, it's the only distribution that we can really find closed-form solutions for.

Modern Portfolio Theorists follow Merton in assuming that time is continuous. On the way down, or on the way up, the stock price hits every tick, (this used to be 1/8 of a dollar, now it's a penny), so you can always get the share price when you put in your order,

These assumptions don't hold. They're made largely because they're the only way to get to a closed-form solution to the math. What's more, anyone with eyes in his head ought to be able to see that they're not even usually true.

Mandelbrot starts from his distribution of cotton prices, and works from there. First, prices are more likely to follow what's called a Cauchy distribution. More peaked in the middle, and with much, much fatter tails, the Cauchy distribution is very ill-behaved.

From there, readers familiar with fractals will find themselves skipping large sections. Mandelbrot reintroduces self-similarity, scaling, fractal dimension, and so on. But he also introduces the idea of time-warping, warping along the x-axis as well as the y-axis. Do this, the produces some very realistic-looking charts.

And that's pretty much where the argument ends. Mandelbrot has produced charts that look right, and returns distributions that mimic reality, but he admits that it's purely descriptive. There's no mechanism, only behavioral speculation, and there's no real way, yet, to make money other than by selling books about it.

What are the implications for finance? Well first, with those fat tails, the Cauchy distribution is much, much riskier than the normal distribution, with the likelihood of ruin much higher. Second, the thing about the realistic-looking charts, that are indistinguishable from real charts, is that they really are random. Technical analysts, beware! Mandelbrot has some sympathy for the illusory patterns you see in the charts, but illusory they are. If I can produce something randomly that looks like the real thing, and you think you see predictive patterns in it that aren't there, what does that say about the predictive power of the patterns you see in real charts?

Mandelbrot also reminds us that he started to come up with this stuff just before the advent of MPT, but that in the trendy world of finance, his uncertainly was overshadowed by MPT's promise of managing risk. He reminds us more than several times, and it does get a bit tiresome. There's nothing the matter with enjoying being right, but even the disinterested observer, who's only looking for something better, get weary of hearing "I told them so."

He make up for it, though, but devoting the last chapter of his book to an uncritical discussion of current research based on his work. He's boosting these guys, with no expectation of recompense, in the best academic tradition, and he deserves credit for that. If he can use his name and popularity to create a community pursuing these ideas, more power to him.

We are reminded that this is a field still in its infancy, not really allowed to grow by an industry that thought it had the magic key. Retrenching and pursuing this line of thought, which currently offers little if any profit path, is hard. But it's better than building on sand, on a coastline whose length you can't even measure.

LTCM Book Reviews

Finally! A two-fer on the book-review site.

It's Carnival Time!

This week's Carnival of the Capitalists is up, over at Small Business Marketing Systems.

After seeing the number of entries grow over the last few months, I've got that "you mean want me to land the plane?" feeling right now...

CFA Blog Rises From the Dead

Finally, I've started reading, so I've started writing.

Big Labor Disintegrates

So another dinosaur bites the dust. Pretty soon, students of American business will look at the 20th Century the way we look at the Jurassic era. "What was the AFL-CIO, and who was this AT&T they had a problem with?"

Big Bill Heyward would know what to do. Before two major unions walked out on their brothers, there'd be finger-snapping and Leonard Bernstein music playing over the loudspeakers.

According to accounts, two, five, or seven major unions, fed up with a leadership that promised enrollment and elections and has managed to squander both, have and will soon pull out of the AFL-CIO and start their own umbrella organization.

Now, this isn't exactly going to force John Sweeney to seek refuge in Avignon, mostly because union membership down to about 1/8 of the workforce, and half of that is public employees. (No, the other half is not newspaper writers.)

Another one of the issues was competition. The dissident unions wanted the AFL-CIO to basically go all the way to godfather, sorting out inter-union disputes, marking out territories, forcing mergers, and preventing competition. That's actually pretty rich coming from the SEIU, which even now is scoping out the juiciest AFSCME territory for raids.

The Ted Kennedys (what union did he belong to? Riverboat pilots?) and Dick Durbins of the world can rail all they want about how Management, sitting pig-like in their boardrooms, smoking cigars in their tophats, are chortling over the self-destruction of their greatest foe, but the fact is, management had long ceased seeing unions that way.

Wal-Mart fights them, of course, but it was the unions that pillaged United and, even now, keep the company alive only to feed on its carcass. I remember talking to the head of one local company whose plant had recently unionized. You could tell, behind all the talk about how a single standard made things easier, that it really hadn't. But it was just a fact of life, not a hazard to navigation.

The new umbrella organization apparently believes that if you're losing elections anyway, your problem may be that you can't mobilize enough voters. So their main focus will be on recruitment. Fine. It also is probably at least a little in response to a membership that was voting 35% of the time Republican, while watching 99% of their political contributions go to Democrats. The UAW was only able to get away with this because of a combination of neglect and cowardice in the face of a very clear Supreme Court ruling.

Still, when most people still associate "union" with "hollow downtown Detroit," it's hard to see where all those new members are going to come from.

Carnival of the Capitalists

This week's Carnival is up, over at Political Calculations. Lots of stuff there worth reading this week.

Carnival of the Capitalists

The Carnival is up!

I'm seriously looking forward to hosting this thing in a few weeks.

Adm. Stockdale, RIP

Admiral James Stockdale has died. For those looking for heroes, Stockdale was the genuine article. Kept in the Hanoi Hilton for 8 years, Stockdale became the leader of the POWs there, helping them survive an actual torture camp.

Jim Collins recounts interviewing Stockdale for his book, Good to Great:

"I never lost faith in the end of the story," he said, when I asked him. "I never doubted not only that I would get out, but also that I would prevail in the end, and that I would turn the experience into the defining moment of my life, which, in retrospect, I would not trade."

I didn't say anything for many minutes, and we continued the slow walk toward the faculty club, Stockdale limping and arc-swinging his stiff leg that had never fully recovered from repeated torture. Finally, after about 100 meters of silence, I asked, "Who didn't make it out?"

"Oh, that's easy," he said, "the optimists."

"The optimists? I don't understand," I said, now completely confused, given what he'd said a hundred meters earlier.

"The optimists. Oh, they were the ones who said, 'We're going to be out by Christmas.' And Christmas would come, and Christmas would go. Then they'd say, 'We're going to be out by Easter.' And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart."

Another long paus, and more walking. Then he turned to me and said, "This is a very important lesson. You must never confuse faith that you will prevail in the end - which you can never afford to lose - with the discipline to confront the most brutal facts of your current reality, whatever they might be."

To this day, I carry a mental image of Stockdale admonishing the optimists: "We're not getting out by Christmas; deal with it!"

Those who like to prate on about the evils of Gitmo would do well to read his memoirs of those years. But then, that would take the guts to confront the most brutal facts of their reality.

Carnival of the Capitalists...

...is up, over at Blog Business World.

So, which ride do you think best represents the market?

McMad Update

Longtime readers will remember a discussion of a new McDonald's being planned for an old neighborhood.

Lynn Pressnall, and aide to City Councilman Marcia Johnson sent the following comment concerning plans for the intersection:

The Colfax/Krameria intersection has been scheduled for improvements including a left-turn light but has not happened previously due to problems with gaining enough land to add lanes and smooth out the off-set intersection. The developer, Drake Development, gave the land to the City in May of 2004. Since Colfax is a state highway, funds were then applied for by Denver to complete the improvements. The intersection will be redesigned.

To be fully informed about the background of this development, and to have a full description of "use by right", please go to our website at www.denvergov.org/councildistrict5. On our site you will have access to statements regarding this development by Councilwoman Johnson, the City Attorney, the Manager of Public Works as well as access to site plans for the development.

This certainly sounds like good news. The amount of land involved appears to be small, and wouldn't have affected the buildings in the strip mall, only perhaps a couple of parking places. I'm not certain how much goodwill this is going to buy the developer, given the level to which relations had deteriorated. But it can't hurt, and it also avoids having businesses at an intersection with a reputation for creating accidents.

Carnival of the Capitalists

Byrne Hobart has this week's up a little early. Go there, follow the links, and print out some posts to read during the slow parts of tonight's NBA Finals game. Like, everything before 4:00 to go in the game...

Carnival of the Capitalists

Over at Gala Time this week. It's better than the opening of Elitch's!

Graduation Day

This is probably more appropriate for a 20-year-old getting a bachelor's than a 38-year-old (gulp) receiving a masters. But there weren't any blogs then.

You go to post with the songs you have, not to songs you'd like to have, I suppose.

Bright college days, oh, carefree days that fly,
To thee we sing with our glasses raised on high. [holds up eyeglasses]
Let's drink a toast as each of us recalls
Ivy-covered professors in ivy-covered halls.

Turn on the spigot,
Pour the beer and swig it,
And gaudeamus igit-itur.**

Here's to parties we tossed,
To the games that we lost
(We shall claim that we won them someday).
To the girls, young and sweet,
To the spacious back seat
Of our roommate's beat up Chevrolet.
To the beer and benzedrine,
To the way that the dean
Tried so hard to be pals with us all.
To excuses we fibbed,
To the papers we cribbed
From the genius who lived down the hall.

To the tables down at Mory's***
(Wherever that may be),
Let us drink a toast to all we love the best.
We will sleep through all the lectures,
And cheat on the exams,
And we'll pass, and be forgotten with the rest.

Oh, soon we'll be out amid the cold world's strife.
Soon we'll be sliding down the razor blade of life. (Oooh!)
(laughter) ... Ready? ...
But as we go our sordid separate ways,
We shall ne'er forget thee, thou golden college days.

Hearts full of youth,
Hearts full of truth,
Six parts gin to one part vermouth.

MBA Almost-Mortem

With one more class to go, and an independent study to finish polishing, it's time to start looking forward to graduation and the post-MBA/MSF career around the corner. But it's also a good moment to pause briefly, turn around, take a deep breath, and consider what I'm on the cusp of finishing.

Let's do the numbers (Light, frothy piano version of, "We're In the Money", please):

• Years: 3
  
• Degrees: 2
  
• Courses: 25
  
• Credit Hours: 100
  
• GPA: 3.72
  
• Hours at Assistantship: 600
  
• Courses Paid For by Assistantship: 6
  
• Courses Paid For by Daniels Scholarship: ~4
  
• Student Loans: ~$54,000
  

Now, Peter Robinson wrote an entire book about this, so I don't expect to be able to cover the whole thing in one blog posting. I'll do what I can.

First, this was a hell of a lot of work. I took courses over the summer, and DU runs on an archaic quarter system, designed to kill off the weaker students at the end of each August. There's a 5-week break that covers Thanksgiving to New Year's. After which, a 20-week marathon, 28 weeks if you're taking summer classes. Total time off between New Year's and Labor Day: 4 weeks.

Most of the courses actually required a fair amount of writing. These could be group projects, case studies, exercises, case studies, problem sets, group projects, mid-terms, group projects, finals, or case studies. Take away Friday night & Saturday, and that meant three years of endentured Sundays, be they to homework or housework. I will say that I cannot recall a single student who complained about our having to hold group meetings on Sundays or weeknights.

Most of this time I was working, too. Ah, yes, working. I remember one quarter when an exceptionally understanding contract allowed me to take 16 credit hours while putting in about 30 a week, and taking 10 during the evenings to babysit printers for the assistantship. Yum. Sleep? I'm sorry, I don't know that word....zzzzzzzz. (There was actually a reason for that. DU used to have a billing system where you didn't pay for any hours above 12 in a given quarter. That extra 4 hours was free.)

While there was never a time when I thought of quitting, there were certainly times when I questioned the value of the project; was I really learning all that much, or was it just ticket-punching? Seeing DU get top-5 honors in finance and top-50 honors overall, two years running, in the WSJ recruiter rankings certainly made me feel better about the whole enterprise.

Part of the reason I never thought of quitting was that first quarter. I had probably the best accounting professor on the face of the planet. I mean good. Buff Honodel is former USAF, runs his class like a drill sergeant, and keeps things lively. I was actually excited to walk out realizing that the numbers embodied actual concepts. And while the less said about the finance professor the better, the class itself made it clear that you could interpret these numbers in a meaningful way.

It won't surprise readers of this blog to find out that I also found plenty of room for participation in the ethics & law class first quarter. I am told - by a reliable source - that when I missed one evening session, the professor looked over and wondered out loud if it was worthwhile even having the class.

I blogged only sparingly about the classes while they were going on. Part of this was just because I wanted to give the thing a chance to play out. Part of it was fatigue: I was writing up case studies for the class as it was. It's also hard to blog as a spectator when you're a participant. I'll spare you a class-by-class rehash of the program, but I assure you I can remember something from every single class.

If DU were to ask me what I'd do to the program, I'd have three suggestions. First, re-introduce economics. Incredible as it may seem, DU's graduate business program doesn't teach econ. That's like being a pilot and not learning about the weather. One course. One lousy course: 5 weeks macro, 5 weeks micro. No excuse, really, especially with Thomas Sowell's masterpieces out there.

Second, make sure that every course referred back to the Foundations courses, the basic accounting and finance. Even the management courses. How can you even think about negotiating a labor deal when you don't know your costs? By the time I took the advanced accounting course, I was using concepts I hadn't even seen in 2 years. Every course.

Finally, include 2 or 3 top-flight Bill James articles in the finance courses. Silly? Oh, no, my friends. You may or may not like baseball, just as you may think of finance as a roadblock between you and those juicy organizational behavior texts. But you can't dispute James's writing, his love of subject, clarity of thought, and above all, his ability to tease meaning from numbers like nobody before or since.

OK. As Crash Davis said to Nuke, "moment's over."

Business Blogging

This week's Carnival of the Capitalists is up!

Hedge Fund Hijinks

I had written before that hedge funds and other major MCI shareholders might have been manipulating the Verizon-Qwest auction process to accept a Qwest bid loaded with equity, that they would then have to race to dump. Now, it looks as though some of them were also manipulating Qwest's share price to help keep that bid credible when it was financially unsound.

The Denver Post first reported last week that Qwest's stock spiked during the last 15 minutes of trading on the New York Stock Exchange from March 28 to March 30 to close above a critical price threshold known as a "collar."

Had Qwest's stock closed below the collar, investor confidence in Qwest's bid for MCI could have been shaken. Qwest was dueling against Verizon, which this week locked in a merger agreement with MCI.

...

Maintaining a certain stock price was key to Qwest's offer for MCI, which in late March was $26 a share in cash and stock. Qwest guaranteed the value of its stock within a 10 percent collar above and below $4.15 per share. Below the collar, MCI shareholders would receive less value for their Qwest stock.

Actually, since the number of shares, rather than the dollar value, was specified in the deal, any drop in share price would have cost MCI shareholders money. The collar was there to limit, not eliminate, such risk. Had Qwest decided to try to make up the difference with even more shares, they could have crossed the 50% threshold beyond which MCI would, in effect, have been buying a controlling interest in Qwest.

Since MCI shareholders clearly wanted cash more than they wanted to run a telecom, this wasn't quite the deal they were seeking. Moreoever, under federal M&A laws, it would have changed the entire structure of the deal, affecting valuation, taxation, and the ability of shareholders to resell their newly-acquired Qwest stock.

In fact, this kind of manipulation, if it in fact happened, is grossly illegal, and harkens back to the Wild West on Wall Street, detailed firsthand by Bernard Baruch and secondhand by Charles Geisst.

Whether or not it happened, the fact that it could have will likely be enough to stir up more calls for further regulation of hedge funds. That's too bad, because there's no inherent reason why funds, any more than individuals, should be restricted in the kinds of investments they can make.

Carnivore of the Capitalists

Red meat for business and economics.

Risk Management

On top of everything else, only JetBlue and Southwest will be profitable this quarter, because they're the only two airlines that managed to hedge a substantial part of their fuel costs.

The Denver Post covers this from the local - i.e., Frontier - angle, and includes this whopper: "Hedges come with risk, and good hedges require a solid balance sheet..."

True as far as it goes, which is basically far enough to back away from the gate, and not much further. Two hundred words isn't enough time to explain why an unhedged position isn't a risk-free position. But shouldn't the fact that the airlines who didn't hedge are getting killed on fuel costs kind of hint in that direction?

Look, you're running an operation that's wildly cyclical, in an industry that may not have shown a profit over its lifetime. Your major cost is the single most volatile commodity known to man, and it's completely beyond your control. Wouldn't you want to do something to protect yourself against that?

Hedging usually does require some up-front costs, but unless you're going to Vegas, selling uncovered calls or buying puts with borrowed money, proper hedging reduces risk.

Once again, it's the smaller, more imaginative airlines that were on top of this, hedging their risks, while the bigger boys apparently couldn't be bothered. Maybe there's a reason they're all in bankruptcy.

Carnival of the Capitalists

Blog home of the Wordly Philosophy.

Live-Blog: The Problematic Style Grid

The talk will be based on a paper by Callahan and our professor, Tom Howard, about the dictatorship of the Morningstar "style" grid. You know: large-cap growth, small-cap value, etc. These began as descriptive, but have now become normative, and their claim is that it hurts returns.

Specifically, their claim is that these boxes don't really represent style or asset classes, but characteristics of the portfolio. What had been intended as guides to the investor have now become strait-jackets to the manager.

5:36 - The boxes in the value-size grid are highly-correlated. Why, then, are they considered asset classes?

5:38 - It also means that an all-stock portfolio becomes a hard-sell, since it doesn't fit into these boxes.

5:39 - "Style" really should mean the method of investing; what do you look for in a company?

5:41 - Stocks that meet a manager's style may not fit neatly into a box. It only makes sense to keep managers in a characteristics box if the following 3 conditions obtain: 1) a manager's screened stocks need to fit into a single box; 2) the screened stocks themselves cannot drift to other boxes; 3) Multi-specialists outperform those who let their portfolio characteristics drift.

5:42 - This system, according to a literature search, did not evolve from empirical data, but from convenience and the above 3 assumptions.

5:45 - First, Russ Wermers (U.Md.) did demonstrate in a August 2000 Journal of Finance paper that stock-picking ability does exist.

5:46 - Wermers also found that small-cap, growth, and good stock-pickers drifted the most, and had a 2.9% excess alpha. (July 2002 working paper.)

5:51 - Asness in Financial Analysts Journal, M/A 1997. A value-momentum specialist actually would perform better.

5:53 - Back-test Graham, William O'Neil, T. Rowe Price, and Neff. Rigidly apply each of these methodologies regardless of the stock over the last 20 years, and see how well the best stocks fit into each characteristic box. In order to avoid hindsight, use only forward-looking earnings estimates.

5:57 - In Graham's case, 53% of the top stocks fell outside the small-cap value box, the best box for his style. The % in value move all over the place, from less than 60% to over 90%. The % is small-cap also drift from about 35% to 80%. Finally, Graham outperforms the Russell 3000 by 8% a year, 1995-2003.

6:02 - You need to have the top 20 Graham picks to get the full benefit of his style. This averages out to his 10th best pick. In any given characteristic box, the best box averages to the 35th best pick. Which throws away almost all the benefit of their styles.

6:05 - Overall portfolio tilt? By combining the 4 styles, you actually get a very balanced portfolio, slightly tilted towards growth, and slightly tilted towards small-cap.

6:11 - The peer groups are M(arket) - S(ize) - V(alue) - M(omentum), rather than Growth-Value/Size. Measuring against a characteristic peer group becomes more complicated, requiring weighting for the boxes, rather than a single box.

6:16 - The correlation coefficients among the "style" boxes are huge, averaging 0.86. The correlation coefficients among sectors average 0.55. If the job of the portfolio manager is to look for low correlations, calling the "style" boxes different asset classes makes no sense.

And for the core paper, that's it. I'm going to try to re-start comments and trackbacks, hoping I've shaken most of the spam.

Portfolio Management Live-Blog

Craig Callahan, Founder and President of ICON Advisers, will be addressing our finance class this evening. We've been told that the press may be there, which, in bloggese, means, "you may preempt the press with a live-blog." (Be careful to distinguish this from Bloghese, a clothing line from central Italy.)

ICON is a value investing firm, basing its methodology on the Graham-Dodd model. For the uninitiated, this means looking for undervalued stocks, as opposed to growth investors, who look for stocks with growth potential.