Archive for February, 2009


Bloomberg has had an interesting progression over the past 6 months on how Milton Friedman’s legacy is slowly diminishing – then again, who’s isn’t?

Here’s the first article, which quarrels with the principles of laissez-faire government, which were made possible through Friedman’s free market ideology – the belief that unadulterated by government policies, markets will determine the perfect prices and interest rates, based on supply and demand.

The article also goes as far as assigning Friedman some blame for the decay of our financial system:

In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies.

Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown.

The follow up article – written yesterday – makes some bolder conclusions:

After a three-decade run, the free-market philosophies of Friedman that shaped U.S. policy are being eclipsed by the pro- government ideas of Tobin, the late Yale economist and Nobel laureate who brought John Maynard Keynes into the modern era.

I generally like Bloomberg’s exclusives, since they’re always thought provoking. In this instance, I also agree with them; however I don’t necessarily believe that Wall Street has given up/will ever give up on Friedman Economics – it worked too well for them for 30 years.

I’m also not seeing this idea catch on anywhere else in the media, nor have I seen anyone blame Friedman the way Bloomberg does (most people are still focused on Alan Greenspan and Fannie Mae/Freddie Mac, neglecting the fact that “deregulation” is almost synonymous with the name “Milton Friedman”).

It would be naive to think we’ll have a paradigm shift back towards the ideals of Keynes/Galbraith (as these articles seem to suggest), since we haven’t yet identified the architect of the problem on a broad enough level – although I think Friedman is a good place to focus a lot of our criticism.


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Berkshire Hathaway disclosed their holdings from late 2008 late Tuesday:

  • Sold half of his stake in Johnson & Johnson
  • Sold 9% (9.5 million shares) of Proctor & Gamble holdings
  • Sold entire stake in Budweiser, now InBev
  • Bought 19.9 million shares of Constellation Energy, and added 7.2 million to NRG (both are Utility companies)
  • And he increased his already monstrous position in Burlington Northern Santa Fe (railroad company) to 70 million shares.

Here’s the rest from Yahoo Finance:

Berkshire revealed several other changes in its holdings, including:

— Sold about 4 million shares of the nation’s third-largest oil company, ConocoPhillips, reducing its holdings to 79.9 million shares from 84 million.

–Sold about 5.4 million shares of Minneapolis-based US Bancorp, reducing its holdings to 67.6 million shares from 72.9 million.

— Increased its stake in industrial machinery maker Ingersoll-Rand Co. to 7.8 million shares from 5.6 million.

— Added shares of industrial equipment maker Eaton Corp. to 3.2 million shares, from 2.9 million.

— Reduced its holdings of auto dealership chain CarMax Inc., based in Richmond, Virginia, to 17.6 million shares from 18.4 million.

— Lowered its holdings of health insurer UnitedHealth Group Inc. of Minnetonka, Minnesota, by 79,900 shares, to 6.3 million.

This is a surprising amount of activity (or reshuffling) for a 3 month time frame – especially for someone like Warren Buffett…Consumer Staples stocks are clearly out of favor, as told by his sale of PG and JNJ, which contradicts his old adage “a man has to shave everyday, so I like to own the company which sells razors.” (that’s the general idea…)

Although the report doesn’t yet say, I would imagine that Berkshire increased its cash position after all of this activity. I think they’re taking some off of the table to “Buy American” for a later time.

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I can’t believe this Op-Ed from Thomas Friedman slipped by me…

Leave it to a brainy Indian to come up with the cheapest and surest way to stimulate our economy: immigration.

“All you need to do is grant visas to two million Indians, Chinese and Koreans,” said Shekhar Gupta, editor of The Indian Express newspaper. “We will buy up all the subprime homes. We will work 18 hours a day to pay for them. We will immediately improve your savings rate — no Indian bank today has more than 2 percent nonperforming loans because not paying your mortgage is considered shameful here. And we will start new companies to create our own jobs and jobs for more Americans.”

The guys from Marginal Revolution have actually been on this idea since October:

We should encourage the immigration of prime-age individuals. Beginning in 2007, net immigration fell to half of its level over the previous five years. Increasing immigration would increase the demand for housing and raise home prices. And note that the benefit would be immediate. Home prices — and the value of subprime obligations — would rise in anticipation of a higher population base. The U.S. particularly needs highly skilled workers. These workers not only would purchase homes, but would generate higher living standards for all Americans.

There are a couple of things we know are certain:

  1. We have too many houses (excess supply)
  2. In order for prices to stop falling, we need to either bull-doze a couple hundred-thousand homes, or somehow boost demand.

If we approached immigration in a Utopian manner (only allowing people who can buy a house), we could (in effect) import demand growth, and decouple from the global recession.


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From The Big Picture:



Meanwhile the S&P 500 declined 30% from 1,200 to 850 in the same time frame – I realize this isn’t a metric of correlation (especially in lieu of the massive liquidations over this same time) but it’s peculiar that there are fewer short sales.

Here’s what I think is really going on…

From Bloomberg:

VIX Jumps

The benchmark index for U.S. stock options jumped to the highest since Jan. 23 as investors paid more to use options as insurance against stock-market declines. The VIX, as the Chicago Board Options Exchange Volatility Index is known, rose 8.8 percent to 47.49. The index averaged 32.65 last year.

Could it be that people are using options instead of formal short sales? When volatility is this high, it is easier and safer (to a degree) to buy a put option to hedge against losses…or set up a synthetic short sale if your risk appetite is higher. Another benefit of buying put options, is we are not victim to the schema of “stocks can only go down to zero, but can go up to infinity,” since we only lose the price paid for the option (should it expire or fall deeply out of the money).

Secondly, when the VIX is at 47, there are rapid swings in short periods, allowing the investor a better chance of executing a profit – If I bought a put on the Dow with a strike price of 8,300 with 20 days until expiration, and the index suddenly jumps to 8,500, there’s no real cause for worry. There is still a very good chance the option falls in the money in 20 days.

In summation, I don’t think people have stopped shorting in an environment like this – they’re just using different tools to do it.

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*As Advertised.

An insightful piece from Seeking Alpha prompted this post, as I’ve noticed deficiencies in the use of certain types of ETF’s:

  1. “USO” – which tracks the spot price of Crude Oil
  2. Any of the Proshares Leveraged ETF’s (short or long – SKF, UYG, SDS, SSO, DXD, DDM…)

I am certainly late to the party of pointing out the leveraged ETF’s, but nonetheless have a few things to say.

First, the explanation on USO from Seeking Alpha:

Here are the current prices for oil contracts with expirations in the next six months. Notice how every contract is more expensive than the one that preceded it. USO follows a simple strategy of buying the current contract and then rolling into the next contract before the current one expires.

March 2009 $40.42
April 2009 $46.22
May 2009 $48.88
June 2009 $50.45
July 2009 $51.28
August 2009 $52.70
Source: NYMEX. Data as of 2/9/08.

Until last Friday, USO owned the March 2009 contract. Specifically, it owned 84,378 March contracts, entitling it to 84.4 million barrels of oil.

But on Friday, it sold all those contracts and bought the April contract instead. But because the April contract cost $6/barrel more than the March contract, it couldn’t afford as many contracts. In fact, if you exclude new inflows into the fund, it could only buy 73,444 April contracts.

Whammo presto, the holders of USO lost 13.4% of their exposure to crude oil. They now control less oil. If the spot price stays near $40/barrel, the value of those April contracts will decay back to $40/barrel over the next month and investors will lose their shirts. If the price of oil jumps 15% in the next month—before USO rolls again into the May contract—investors will only break even.

Basically, because the price of Oil is upward sloping, the parent fund has to cost average-up at the beginning of every month – they have to reinvest all of the money from expiring contracts at a higher price – meaning there is less firepower behind the investment.

(The author makes reference to “contango,” which may sound complicated but isn’t…it’s just when the Oil futures price is above the spot (current) price).

The Leveraged ETF’s, on the other hand, aren’t flawed per se; it is our perception of how they should work which is flawed.

This concept was well covered by the Wall Street Journal, and by Jim Cramer, who through the powers of cognitive dissonance decided that the Ultrashort Financials ETF (SKF) brought down the bank stocks in January (The author of the Proshares article from thestreet.com provides analysis on how this is somewhat true).

Here’s the WSJ excerpt:

The issue is that these funds are designed to double the index’s return — or double the inverse of that return — on a daily basis. The compounding of those daily moves can result in longer-term returns that have a very different relationship to the longer-term returns of the underlying index.

For example, take a double-leveraged fund with a net asset value of $100. It tracks an index that starts at 100 and that goes up 5% one day and then falls 10% the next day. Over that two-day period, the index falls 5.5% (climbing to 105, and then falling to 94.5). While an investor might expect the fund to fall by twice as much, or 11%, over that two-day period, it actually falls further — 12%.

Here’s why: On the first day, doubling the index’s 5% gain pushes the fund’s NAV to $110. Then, the next day, when the index falls 10%, the fund NAV drops 20%, to $88.

The funds themselves are tricky, but if you understand that making 10% is different than losing 10%, then this should make perfect sense.

End Lesson: These are instruments made for day traders, not long term investors.

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