Thursday, December 07, 2006

"My View"

In preparation for a job interview, a friend asked me, "be sure you have an answer if they ask your view." My view? What do you mean? "Your view of the economy, of financial markets, of a good stock pick..." One better than that - here is a whole slew of various views. Some of which have already come true:

Urban trends: Today the AP reported that more suburbanites live in poverty than urbanites. My prediction has come true: People moving to the suburbs to escape crime and poverty are now confronting it in the suburbs. Suburban master-planned communities' inexpensive home boxes and strip malls that were once gleaming stucco and brick (a whopping 5 years ago) are already showing their age and looking more dilapidated than the urban center of cities. The guy I wrote to in the WSJ, Joel Kotkin, likes to say the idea of urban redevelopment and responsible development are crazy liberal and elitist. He always counters with the great example of Sugar Land, TX: a microcosm of America with an abundance of jobs and cheap land. I'm not sure when was the last time he saw Sugar Land (or where in Sugar Land he lives), but it's not looking that great. Houses that were built 10 years ago are already over-run with broken down cars and weeds. The MBA nerds who developed the communities have moved on to their next projects, while the good citizens with dreams of starting a family and owning a swing set and swimming pool (death traps! :-) are stuck watching their neighborhoods turn into the hood. Grand 6-lane boulevards in Sugar Land are now lined with shuttered storefronts, tiny propped-up trees, litter, and crabgrass.

Stock pick: I love Starbucks, it would be a blast to work there. So should any prospective Starbucks employer read this, be impressed rather than annoyed when I say "short SBUX." How is it SBUX can trade at 50 times its earnings? Ostensibly because Wall Street expects its sales growth to continue at 20% annually for at least the next 10 years. More likely there is a disconnect between expected performance and behavioral bias. A 10 year 20% sales growth justifies a PE ratio of 50/1. You don't have to be a fundamental analyst to know that something is wrong with that scenario. This year SBUX's revenue growth was a whopping 19% - congrats!. But despite Starbucks' recent announcement to increase its long-term store opening total to 40,000 (from 30,000 ... currently there are about 13,000 stores worldwide), a 10-year 20% revenue growth rate is highly unlikely. That is like saying Wal-Mart will grow by 20% for 10 years when investors know that would equal a Wal-Mart on every street corner (including Cedar Mills, Oregon).

Update: As of May 1st, if investors followed this advice in November, they would have earned about $1600 for every $10,000 shorted. SBUX is a great company, and I hope I can work there one day. This analysis just illustrates how basic industry knowledge can yield big gains.

Investment strategy: Unless you have millions to spend in a hedge fund (or an ETF - poor man's hedge fund), simply invest in a passively managed index fund. You can capture some positive beta in a passive fund - mostly because the management fees are kept to a minimum. Active managers try to capture alpha but end up performing virtually the same as passive - except active management costs money! In the end, you're better off without their help.

Next Step: optimize your portfolio. To do this, all you need is market returns. Calculate as follows: 1) Make a list of all the funds you can invest in and get their returns for the last 5-10 years. 2) Find out the annualized mean and standard deviation for each of the assets. 3) Calculate the correlations (or covariances) between them. Excel does this in one simple formula. 4) Use Excel's solver feature to determine how much of what fund to invest in. Easier said than done - Excel doesn't have a "portfolio variance" function, hence my earlier blog post complaining to Microsoft. If you want to learn more about a 2, 3, or 6 asset optimization model, just ask. Anything above 6 assets is just silly unless you're willing to learn Excel's ridiculously tedious matrix multiplication functions (If my employer wants this, I may learn it).

Term life insurance vs. whole life insurance: The basic premise of Todd's and my investments project is "buy term and invest the difference." That is: buy temporary, short-term life insurance. At the same time, start investing all of the money saved from not buying whole life insurance into your 401k. Specifics of the analysis can be found here and here.

Macroeconomy: I envision a day - sooner rather than later - when something happens in US / China relations that causes the US economy to basically collapse. Perhaps set off by a geopolitical event caused by some minor tiff. Or perhaps because the US Congress will keep adamantly pushing China to float its currency against other currencies. But the end result will be the US stuck with a trillion dollars of debt to pay off. The big issue with floating currency is that China keeps theirs artificially low. For the longest time I didn't quite understand what this meant. Basically, China keeps its currency "artificially low" by economic chicanery. The biggest trick up its sleeve is to buy lots and lots of US bonds. China: "We buy US bonds today - the most secure, no-risk investments on planet Earth, and get a modest return from the US government tomorrow." A couple of the results of this are seemingly innocuous act are:

China's currency is "artificially low" because China is buying so much US currency, thereby making sure that its currency, the Yuan, stays incredibly stable. For the longest time it was 8.2 yuan : $1. Seriously, for like 10 years it was 8.2 yuan to $1. In the meantime, every floating currency in the world did something more interesting than that. Now Chinese mom and pops can sell their goods to America and the rest of the world at prices that cover their own costs + profit. And yet because their currency is so low, whatever price the mom and pop sold their plastic toys for is artificially low and American (or any other countries') firms cannot compete. This is the main gripe of the US Congress. "Our firms cannot compete against an artificially low Chinese currency!" Hence the entire US economy is also affected. Additionally, US home mortgages are kept artificially low. China subsidizes our ability to obtain low mortgage rates.

Eventually China will change its domestic policies and it will effect the USA. China will stop buying US bonds and sell its US bonds. The US will be stuck with a horrendous bill to pay. If the US doesn't default on its debt, the good US citizens will be forced to ante up. Big increases in long-term interests rates, no more toys inside Lucky Charms, and significant job losses - especially in the service sector. You can imagine the spiraling effect of this scenario. And the sad truth is that it will happen. Eventually, China will sell its US bonds - its inevitable. No one really seems to care about this, but your economic future depends on how China handles its domestic policy.

Armageddon: I remember watching the 1972 ultra-cult Christian classic (a very niche category) video A Thief in the Night with fear and trembling. Imagine “bell-bottoms and free love” meets “fire and brimstone, end-of-days eschatology.” The premise is as follows:

· Step 1: Every believer disappears

· Step 2: Every disbeliever who “almost believed” was left behind on earth to suffer seven years of intense persecution from non-believers. Non-believers progress from “what happened, millions of people disappeared” to “let’s all fight each other” to “we need a leader to unify us – this guy seems really charismatic, let’s elect him our supreme earthly leader” to “oops, we chose our leader incorrectly. I guess he was Satan incarnate. Here comes the Lord on his fiery chariot to punish us all.”

Along the way, meteors, pestilence, and war ravage the earth for seven years. It’s a very intense story, and both A Thief in the Night and Left Behind paint an extremely bleak picture. Throughout it all, however, Christians escape as being virtuous and smart; while those left behind are carnal, primeval warmongers.

All that to say: The book of Revelations states that “Only God knows when He will return,” and that any attempt to guess when he returns will be utterly futile. Despite this truth, Christians universally believe that end times will be caused by the violent tendencies of non-believers. Therefore, it is reasonable to deduce that because Christians seem to universally think Armageddon will occur almost uniformly the same way, God will no doubt surprise us all.

I foresee that Christians themselves will unwittingly cause Armageddon. Yes, Christians just like me. My “view” gets hazier after this. Several scenarios could follow, including:
General macroeconomic malaise covers the planet. Possibly instigated by China dumping trillions of dollars of US debt, possibly caused by the Middle East malcontent with seeing the excesses of Western culture as their own governments continue to espouse 7th Century economic principals (such as “interest is immoral”). More likely, the divide between the haves and the have-nots continues to grow, creating Marxist-type leaders (a la Hugo Chaves) that endorse class warfare. Economic imbalances beget bickering, begets fighting, begets terrorism, begets warfare. The US enters the thick of the problem, trying to solve the world’s ills by using what Jim Wallis calls our only diplomatic tool, “the hammer.” We pound and pound at the world, trying to solve its problems, until we unwittingly lead the world to the point of no return.

The key to this scenario is that all along, the US was run by a strong, evangelical Christian. Someone who reflects the voters’ own values. Someone that reflects their own moral principles. This leader isn’t necessarily good, but “good” leaders are no longer necessary because we’ve created a political system whereby what “feels good” and is “identifiable to our self-schema” takes precedence over a solid Jeffersonian or Lincoln-type leader (an otherwise crazy character who happened to be a great founding father. You think Jefferson could ever get elected today?). Every night, before s/he goes to sleep, like King Solomon, our US president prays that s/he makes Biblically sound decisions. Those decisions, today, mean “Old Testament” rules of engagement. We can see some of these well-meaning Old Testament rules of engagement in our society even today.

The Lord will use our future US president – a good, solid, morally upright Christian – to fulfill his own ends. After the fact, no Christian will have guessed the tragic comedy of Armageddon. They had been trying to interpret signs of evil extremist warlords and Russian presidents without ever considering that their own Christian leaders might be the ones to set a course towards Tribulation.


Dougie Fresh said...

Looking forward to the view on Armageddon. Let's hope it doesn't happen before you get to share.

Merry Christmas! =)

Bob Mardock said...

Okay. Waiting on this with great interest.