Kick the Tires Real Hard, Global Province Letter, 31 August 2011

TV Pundit: What do you think is driving America---ignorance or arrogance?
Titan of Wall Street: I don't know. And I don't care.

The Nifty Fifty. Back in the early 1970's the stock market took a terrible fall. At that time a big, important corporate bank in New York City called Bankers Trust (it is no more) told a young manager who managed its fund of very promising small company stocks that he and it were history. His stocks had plunged, and Bankers decided to focus on big capitalization, hot-performing, well-known stocks like Xerox and Polaroid. In other words, it bought into the Nifty Fifty.

This was a horrible decision. Like Bankers Trust, many of the companies in the so-called Nifty Fifty have since disappeared. None would be called hot numbers today. The young portfolio manager, on the other hand, went on to work for one of the good companies in which he had invested. Later on, we hired him to manage one of the funds we were administering. He achieved spectacular results.

In our 2009 Investment Outlook we cautioned you to look for institutions and companies that are driven by honesty when investing, since it is now such a rare commodity. In 2010 we said you should pursue extraordinarily deep value investments. Now we must remind you of the terrible crash in the 1970's where all the big guys were wrong---full of bad advice and pursuing business policies that would eventually either extinguish or cripple their companies. Amidst terrible global financial and economic dislocation, one must turn one's back on micro thinkers and, metaphysically, take on the globe.

An article in a national journal the other day pointed out that the brokers and institutional salesmen are recommending funds, and bonds, and all the traditional junk put out by Wall Street houses. Yet a goodly number of them have their own money in cash or Treasury bills. They don't know what they're doing investment-wise, but they know they have to sell something to us to make a living. In 2008 Goldman and many of the other prominent houses were selling structured financial vehicles and subprime mortgages, even when they were personally shorting the stuff. In other words, cupidity, arrogance, and ignorance were and are driving financial intermediaries to push financial, air-filled wonder bread not worth pushing. The prudent investor now has to overcome (a) arrogance and (b) ignorance.

Arrogance Aplenty. We're now peppered with humongous companies that are not particularly well-run but grow anyway, because of a lack of real marketplace competition. What a person needs to do is kick the tires one, two, three, or four times and see what happens. Oft as not, the tires will go flat.

The cell phone companies are a simple example of what commonsense will reveal. Before Judge Greene came along and broke up AT&T, America had a benign telephone company that was a pretty well regulated monopoly. Now our telephonic communications are dominated by a small band of very costly freewheeling monopolies. The result is that our mobile phones are poorly built; we have poor national coverage, patchy service with conflicting technical standards, and we pay way too much for all of it. For example, one of our employees found out that it was cheaper to call his home in Indiana from Germany than from the East Coast of the United States. Jerry-rigged and outrageously expensive, these companies are not good long-term investments, since they will have to be rebuilt and regulated in time.

Likewise, the large banks, the major media companies, and an endless list of other goliaths are simply peddling bad products. The lesson of the current continuing financial crisis is to steer clear of companies peddling hollow merchandise. The Harvard Business Review, which is not much of a publication anymore, ran a terribly important article on "Companies and the Customers Who Hate Them" in June 2007. It cuts right to the heart of the matter. In the present volatile business climate, one should not buy the stock, or the advice, or the products of any company one loves to hate. It will not survive, nor will you if you are linked to it. Should you find a company or its wares repugnant, it is undoubtedly arrogant and not a good companion for a humbling age.

Overcoming Ignorance. In good times, investing seemed to be a formulaic business. In the past, some investors would focus on annual growth in earnings, looking perhaps for 15% growth every year. Others would pick oil, others technology startups. In the past any fool might make a nickel, or at least not lose too much. Now such a simplistic outlook will devour one's assets.

We learn that the fellows who are earning a premium today are global macro investors who are following a host of indicators and are darting here and there about the globe with their computers. Brevan Howard, a large macro hedge fund in England, has made $1.5 billion over the last 3 weeks, given its broad-based approach.

A more serious look at the macro fund approach can be had by reading John Cassidy's "Mastering the Machine: How Ray Dalio Built the World's Richest and Strangest Hedge Fund" in the New Yorker.

"Dalio is a "macro" investor, which means that he bets mainly on economic trends, such as changes in exchange rates, inflation, and G.D.P. growth. In search of profitable opportunities, Bridgewater buys and sells more than a hundred different financial instruments around the world—from Japanese bonds to copper futures traded in London to Brazilian currency contracts—which explains why it keeps a close eye on Greece. In 2007, Dalio predicted that the housing-and-lending boom would end badly. Later that year, he warned the Bush Administration that many of the world's largest banks were on the verge of insolvency. In 2008, a disastrous year for many of Bridgewater's rivals, the firm's flagship Pure Alpha fund rose in value by nine and a half per cent after accounting for fees. Last year, the Pure Alpha fund rose forty-five per cent, the highest return of any big hedge fund. This year, it is again doing very well."

It is felt that Bridgewater, Dalio's organization, makes money because of its overseas focus. "Although the firm trades in more than a hundred markets, it is widely believed that the great bulk of its profit comes from two areas in which Dalio is an expert: the bond and currency markets of major industrial countries. Unlike some other hedge funds, Bridgewater has never made much money in the U.S. stock market, an area where Dalio has less experience." Be that as it may, Dalio can be said to make his money by trading the world, a global approach which leads to balance and diversification.

Right now the United States is convulsed by inertia and confused by both ignorance and arrogance. It is a very good time to play global hopscotch if one can learn the rules.


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