Monday, August 14, 2006

InfoUSA to buy Opinion Research Corporation

At a 85% premium!!!

It's a small world after all!

On Political Risk

Though the pen is mightier than the sword, and philosophy the mother of all lasting authority, civilization--when it begings--is built upon a foundation of force and violence. Our world today is not too different from the world eons ago, where man fought one another for reasons that might include one of these: (1) scarce resources or (2) ideological dominance. The former is purely economic, where those with lesser and poorer populations loot a more powerful neighbor for survival, in which the intellectually and materialistically impoverished peoples gather against a larger people who do not share in the misery. The latter is more or less philosophical, often fought between parties of equal strength, sometimes also serving as a guise to justify more economic reasons for warfare, that bring not only necessity and survival into the game, but also propaganda in the name of the good, the just, and the righteous, and whoever wins obviously had all three on their side. Power comes before civilization, and brute force opens the gate to knowledge and economic trade. Those who dabble in the benefits of civilization must never forget the legacy of blood and realpolitik behind every lasting peace.

Likewise, those who dabble in blood and realpolitik should never forget how to harness peace to bring the benefits of civilization.

Anyone who prospers under peace usually do so through the creation of value, and that usually means production, commerce, and finance in one form or the other. Of course, most countries in our world today can at least call themselves a "nation" if nothing else, even though some probably do no better than nomadic tribes under that title, and the benefits of national soverignty that come with it including a government, a standing army, and at least some infrastructure to support the rule and law of both. Such benefits, however, are too often perceived as "enough" or "as good as it gets", though it may be no where near the standards that must be in place in order for prosperity to take root, though the facade of peace and control may exist.

While the capital markets do not discriminate between "right" and "wrong", or between what's "warm-hearted" and what's "cold-blooded", it at least knows perfectly well the conditions under which wealth and prosperity of a people must operate commercial enterprises and participate in trade. After all, one of the greatest perks to civilization is specialization of skill which brings those who know best to provide to society with the fruits of their best-practices in exchange for others' best-practices, and a society which facilitates this sort of exchange is a society that ultimately prospers, and a society that seeks to dampen free-exchange and commerce for whatever reasons may be will find itself destroying value and alienating itself from the forces of economic progress.

Venezuela is a case in point. President Hugo Chavez, through an interesting twist of socialist ideology, have decided to nationalize many of the country's energy and mineral assets in order to finance the demogaugic promises widespread education, healthcare, and crime reduction. To the investment community, this is horrible news, and Venezuela will have successfully cut itself out of any promises of future benefits and welfare that result from foreign capital and investment. While education, healthcare, and the safe enforcement of law is important to any society--the tax at which Venezuela extracts against the world's capital is too great a burden, and like any investment that simply do not make sense from a cost-benefit perspective, the wonderful promises are sure to be empty as financing escapes the tentacles of these so-called social initiatives which have unlimited costs. Decades from now Venezuela will no doubt find itself to be a poor country with nationalized and yet undeveloped reserves of natural resources as the world shuns its lack of protection for the individual.

When the capital markets speak of political risk, they are speaking of simple initiatives in favor of individual rights--starting with the right to property--that a country lacks, which dampens any "rule of law" that might protect an investor's interests from being nationalized or expropriated, which often have unreasonable compensation schemes that completely disrespects and mocks the hard-earned value in which a corporation or an individual works to create and maintain. Though "a fight to take from greedy capitalists what naturally belongs to the people" might make a great demogaugic slogan, it completely throws one of the most important rights of man: the right to own. While equality and social justice is important to a certain extent, such should not come at the expense of the individual, and any society that deviates philosophically from the free-giving of freedom in building wealth and enterprise, then, should be best avoided by the investment community at large.

On Market Timing and Value Investing

It's no news that the market has been completely tanking over the past couple of months. Institutional investors, fund managers, and retail investors alike are pulling their hair out while watching their the best of ideas and the worst of ideas going down down down. So a few questions regarding this sudden downturn should be posed: what is happening? what is to be done?

We are in a period of a much needed correction on the stock market. In a way, we were still feeling the effects of the economic recovery as a result of Greenspan's relentless easy money policies from 01/02 on--until now. Back when interest rates were eased down to nearly 1%, the hope was the excess amounts of easy capital to business people would be enough to finance capital investments to save the economy from an oncoming doom. The stock market was thus saved, as people got out of fixed income investments because of the low yield and put money into equity investments again. As the stock markets began to rise, investors once again had the confidence that they had lost after the tech bubble, and the stock market became, for a short period of time, the investment vehicle of choice once more. The market gained momentum... and everyone made money, though not anywhere near the amount that people lost in the burst.

So what's happening now? To answer this question, one must first aggregate everything that has happened in the stockmarket the market for the past five years. Before the bubble burst, stocks were allowed to rise to cosmic levels in praise of a "new economy" where financial valuation no longer mattered, and earnings were expected to be able to rise on forever and ever. The over-valuation of equity investments were obvious, but no one really cared. And as the fate of any investment bubble in the financial history of man, it was destined to burst. However, one should be aware of something that often escapes observation. The bubble burst never actually corrected stock market valuations to its historical levels. Meaning, the stock market after the bubble should have crashed lower than it should have before it started to recover during the latter 2002/early 2003. One only needs to look at what happend to interest rates during the crash:

In a way, the Fed saved the markets from an even heavier downfall by decreasing interest rates almost immediately after to historical lows (interest rates that haven't been seen since the late 1950s). By doing so, the Fed has successfully taken the interest out of bond-investments, and thus, naturally--hungry for returns, most investors went back into the equity markets again without the stock market having hit its bottom. It's very important to emphasize the role of the Fed in brining the stock market back up during the past couple of years away from the perceived doom of 2000 - 2001. One can look at the current price investors are willing to pay for the future stream of corporate earnings vs. the historical average level that investors were willing to pay that's been around for many many years:

Taking a look at the end of 2005, it doesn't seem to be too far off from historical highs. Meaning that, in a way, we are still in a period of overvaluation in the market, and that valuation after the bubbles crash can only be considered "relatively low" compared to the heat of the 90's as the tech era boomed. Of course, many could argue that we have reached the highest levels of productivity that mankind has ever seen, with countless number of new innovations that have facilitated efficiency gains beyond anyone's dreams before the advent of the technology boom. However, I fail to grasp how this should affect financial valuation. As much innovation and productivity gains that the American business landscape has seen over the past two decades, the fact that businesses still compete for market share and businesses still compete for capital do not change. And thus, why would financial valuation change? It's not as if a business will be able to make higher returns with less risk than before. If anything, the risk has increased and returns have decreased as a result of a "flatter" business environment.

So, what the Fed right in coming to the rescue back in 2001 when they decreased interest rates to where they were? Yes and no. Yes in that America badly needed an injection of confidence to prevent recession/depression/whatever. No in that the Stock market still needed to go down more.

Anyway, back to present times. Alan Greenspan probably realized that too much money was created in the economy, and started raising interest rates again not too long ago. Bernanke has continued this legacy. But why is too much in the economy bad? I've heard many "average joes" asking very difficult questions such as why "the Federal government is trying to bring down the value of their homes?", or why the government is "trying to create a recession at the expense of the people?". How do you answer these questions? Can you simply tell people that, well, they made too much money with historically low interest rates, and these extra monies went towards intangible investments and bubbles such as (in order of appearance) the tech bubble, the nascent mini-recovery in stocks, and real-estate? No... you probably can't, because chances are, the average joes didn't really make that much money in the tech bubble, and the value of their homes is the only real tangible capital gain that they have seen over the last few years. It's the "smarter" people that got away with real value... like, perhaps the now-famous Andy Kessler who got away just in the nick of time when the bubble burst. So, the average joe got screwed then during the bubble, and they will probably get screwed in the next couple of years that the Fed is tightening to take the extra money (including the gains in home prices) away from the economy (god knows how many people actually went through with taking mortgage-equity out of their homes).

Bernanke is continuing the tightening policy in order to take all the excess liquidity and M2 out of the system. And by tightening, the stock market goes down as returns are discounted at ever increasing risk-free rates and bond markets look more and more attractive to investors that don't want to deal with the risk of capital depreciation. The market has been going down finally for the past few months as rates broke the 5% mark since the lows that it has hit during 2001 - 2002. We can already hear the griping of equity investors begin--and what do you know, they are hammering for a "pause" and an "ease".

Bernanke threw them a bone in the last speech he gave congress--which, by the way, was hilarious because of the congresspeople's insistence that a pause should happen right now (especially the ones with lobbyists from the housing sector and the mortgage financing sector). Bernanke said that the Central Bank would now be more careful in considering many factors that are facing the U.S. economy, including:

1.) The effects of past interest rate hikes in the pipeline that have yet to hit the economy
2.) The possibility of a recession on the horizon and the fallibility of an overhike
3.) The possibility of even more inflation if the previous two scenarios don't play out.

So, anyone dabbling in the equity markets must beg the question... what is to be done?

Will the Fed pause? Or will they keep tightening? Or, everyone's favorite, tighten one more time in August and then ease up?

There is one answer for the value investors--and that is: keep on truckin' :D
As the vagaries of the market and the fed seem to be endlessly unpredictable and volatile, there is almost no certainty and no risk-control in a situation where the average investor is powerless against bigger things than themselves. To rely on the performance of one's portfolio on the effects of the market is akin to taking seriously a young woman's perspective on the "right" kind of man... both are easily swayed by the seasons. So, it is best if serious investors stayed out of the market as a whole, and instead, looked for investments that have "value", not "price".

Of course, even value investors must weather the ups and downs of the market. Any investment in a portfolio lacking immediate catalysts could be subject to heavy correlation with how the market performs. The fact that everyone dabbles in every stock won't change. And since it is indeed everyone that invests, good stocks can face bad returns in down-markets. In a way, I guess I am a hypocrite, in that, I do my best to criticize the market's overvaluation, and yet, I should curse and suffer too if the market corrects itself by falling since I am a part of that everyone.

However, market-risk is one thing, fundamental-risk is another. Market risk is the kind of risk that gives you gains and losses in volatility swings, but fundamental-risk is the kind that gives you a permenant gain/loss of capital. The difference between value investing and investing with an eye on the market is that the former should only care about the permenant loss/gain of capital, and have a strong conviction that so long as the crux of the fundamental investment thesis do not change, value will out despite short-term short comings.

Of course, that kind of thinking is also dangerous in many respects. Unless one completely understands the investment that one makes, it is very difficult to have that level of conviction that is required to stick it through a great many deal of short term losses... and oftentimes, volatility can often be distorted by emotion to become perceived by investors as a permenant gain/loss of capital every time the ticker moves. Loss aversion is there for a good reason, however, when the fundamental value of anything is worth more than the price that the market currently assigns, then value should out, eventually, even if the market thinks otherwise.

That's not to say that the people who correctly make money on market swings are any less intelligent than value investors. On the contrary, many market-timers I know are brilliant in every respect... and most can make money on advanced mathematics and financial derivative trades that most value investors will probably never understand. However, the philosophy is different. Successful market-timers make money on derivatives and hedging, while value investors make money mostly on long-term equity investments. It helps to have a little bit of both, but no strategy is perfect.

And well, I guess my conclusion: as value investors, there is a conviction that so long as discounted equity are correctly assessed, one does not need to worry too much about the vagaries of the market... only fundamental changes that would change one's thesis. As the market goes through a period of much needed correction, the market will be flat at best, and down at worst. Well, value will out no matter what the market does, but personal discipline and constant thesis checking will be the responsibility of every value investor as pride, love, fear, greed (well, maybe a little bit of greed), and soothsaying cannot ever be allowed to affect one's judgement in what is "value" and what is not.

Of course, the trick is to make money on a down market. Oh value, where art thou?

Chinese market sucks

Call me a China bear… it’s unbelievable how messed up China’s financial situation is. I came here thinking that an inefficient market would breed profitable investment opportunities. Inefficient it is indeed, but not in a good sense. Here, the inefficiency is not so much investor inefficiency or hidden value. Here, the inefficiency is on an infrastructural and fundamental level the market system. I guess I had to have seen it with my own eyes… but the bottom line is that the Chinese stock market really sucks, but nobody seems to care. The valuations are through the roof!

Though I cannot say I have looked at all Chinese companies to know if all Chinese stocks are as bad as what I am about to mention… I’ve seen enough of how the system works to know that without the proper frameworks, China is only a fa├žade of capitalism. Of course, things should get better slowly from here as the Party is trying very hard to set policies favorable towards the development of the capital markets. But the way it seems right now, real lessons will probably only be learned if a severe fundamental correction that really hurts happens within the next five to ten years. Only then can the widespread pseudo-wealth of fiat currency created through bad bank loans, the bogus financial disclosures that detail very much but say very little, and the horrible conflicts of interest that exist on almost every level of finance be wiped clean.

But anyway, enough with the small-talk… I have five reasons why China probably won’t be able to sustain its meteoric rise in the next five to ten years. Although I cannot say that China would not be a good investment in the long-run, I’m fairly certain that at the rate China is growing presently, a severe fundamental correction will take place in good time. A simple explanation of why:

(1) A bad case of bad loans outstanding caused by numerous conflicts of interest between politics, economics and guanxi.

(2) Which brings crazy growth in money supply that cannot find value-generating investments. Which brings inflation on intangible/big-ticket items such as real-estate, commodities, and equity (in a way this goes for the entire world too)

(3) That causes social inequality, and the “income gap” continues to widen, with the government continually having to find itself subsidizing the poor mainly in rural areas and urban slums who have virtually no investment opportunities available to them to keep up with the times and yet have enough will to live and breed at an increasing rate. They in turn…

(4) Continually bring inexpensive labor on the market and continue to consume inferior goods and services on a second-tier economy (sometimes black) that is tied to a currency—the Renminbi—that continuously loses value domestically due to inflation, and increases in value paradoxically relative to the rest of the world because Mr. America thinks inexpensive Chinese products are a result of an undervalued currency and not a result of an excess labor market and an overflow of people desperate for work. So that when the Renminbi actually appreciates in value, strangely enough domestic inflation will also go up (as China is not an import economy) with exports failing and unemployment rate rising.

(5) In turn, so long as there are enough currency in circulation for the wealthy to continuously invest in projects with negative value or intangibles, manufacturing, commodities, and excess export capacity will continue to grow at an alarming rate without regard to margin… and even the most saturated of markets will be subject to ever-increasing investment because, where else would the glut of currency go? Until all falls down as loans must be written down, and money supply must naturally contract.

Oh! What’s the catalyst? One might ask…

A slowdown in international demand for Chinese goods I say! Value will quickly contract then. People speak of domestic demand picking up that could perhaps offset the slowdown in international demand… that might be the case, except for one small problem: the majority of Chinese are poor. The high and middle class cannot possibly create enough demand (and do not have enough logical reason to buy) for goods that are propping up the Chinese economy: cheap apparel, cheap electronics, cheap toys, etc.

Wealth disparity is one of the most economically disastrous problems… for the rich get richer to buy goods produced by the poor… and the poor produces hordes of supply that cannot possibly be consumed, which must be sold for ever lesser values, while the wealthy have nowhere to invest except intangibles such as tulips, imaginary stocks, and commodities like gold (gold is another story altogether)… until one day *poof* money goes away magically, just like it appeared as mere flickers on a bank-machine.

At least America invests in intellectual property and innovation… where do the Chinese invest? You guessed it… bad businesses, intangibles, and U.S. treasuries (at least they are long-term treasuries that destroy value and burn excess money as U.S. interest rate hikes continue).

I’m very bearish on the Chinese market. Cash will get burned… bad habits won’t change until their short-term advantages turn into short-term woe…

And you know what? Shorting is illegal in China, and there is no active bond market… in short, the transfer of risk to stupid people who deserve to get their money burned does not exist…

Let the anti-climax unfold! (I must remind readers that this anti-climax might happen next year, or five years from now, even ten years from now… however long the Communist government can inject money into the system to pretend everything is alright… but alas! The longer the denial the greater the demise. Such… is life :D)