Buffett’s Letter and March 1 Update

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Now, on to what I read…

1. Markets

The Dow went up 4.23 points on Friday to end the month at 10,325.26.  For the month, this was an increase of 2.6%.  The month was highlighted by fears about Greece and the Fed raising rates, Bernanke’s assurances that rates wouldn’t rise and a slew of corporate earnings.




Insider transactions. According to Vickers Weekly Insider Report (as mentioned in a NY Times article), the ratio of the numbers of shares that insiders sold over the previous eight weeks to the number they bought dropped to .45 in the weeks before the bear market that ended.  That was the lowest level since December 1990.  Of course, the market rallied both times.  By November 2009, the ratio reached 5.21 – signaling a potential decline.  Now, the ratio is back to 3.52 (which they interpret as less pessimistic).  The long-term average is 2.5.

WSJ asked whether a run on the sterling is next. The pound hit a nine month low against the dollar and a six-week low against the euro.  They described three fears:

1. the depth of the recovery
2. worries that the BOE will print money
3. political uncertainty (unclear winner in upcoming elections and no agreement about how to deal with their deficit)

Appreciation depreciation. It’s interesting to think about the fact that if China lets the yuan appreciate, the yuan-based value of their Treasury holdings will drop significantly.




Correlations increasing? In the first two months of 2010, the Dow is down 1% and the Dow Jones / UBS Commodity Index is down 3.8%.  Some investors are afraid that these two asset classes are starting to sync up – which is what they did during the financial crisis.




Copper prices are rising. Chile is the largest producer of copper.  It looks like prices are up ~5% as a result of the earthquake.

2. Economy

Q4 GDP revised up from 5.7% to 5.9%. The enhanced numbers reflected more of what we already knew provided strength: a slowdown in inventory liquidation.  This accounted for 3.88% of GDP growth (up from a previously reported 3.39%).




Existing home sales fell 7.2% in January to a SAAR of 5.05MM units.  After the spurt from the tax credit, the market has returned to a weak state.  Inventories rose to a 7.8 month supply (from 7.2 months).




The University of Michigan / Reuters consumer sentiment index dropped to 73.6 in February from 74.4 in January.  People were more optimistic about current condition and less optimistic about the future.




Permanent job losses? Thirteen percent of companies cut pay between late 2008 and October 2009 and 29% of those planned to rescind the cuts in the following 12 months.




Government has not cut employees. Private businesses have fired 8.5 million workers (7.4% of those on private industry payrolls) since employment peaked in December 2007.  Local government, on the other hand, kept hiring through September 2008 and since then has only fired 141,000 employees (less than 1% of the 14.6MM on their payroll).  Job security and a pension (for many)…that’s a pretty nice deal.




Time to renegotiate? The FDIC is putting together a plan to test whether cutting mortgage balances would prevent foreclosures.  I came across an article arguing that homeowners should do this on their own.  They should tell the lender that “you’ll lose 50% if I default, so you should reduce my balance by x%.”  To me, this just doesn’t make sense.  If I was running a bank, I’d have no idea of which underwater borrowers will default and which will honor their agreement.  If I start negotiating, many borrowers who wouldn’t default may knock on my door.




3. Sovereign Debt

Brutal! The Greek Prime Minister said “brutal steps” were necessary to solve the country’s finances.  Supposedly, the current steps will only reduce the deficit from 13% of GDP to 11%.  The goal is to get this down to 9% in this year.

Additional austerity measures could include increasing the VAT (currently 19%), more cuts of public-sector pay and more tax on luxury goods.  The EU has asked Greece to discontinue one of two extra monthly payments that public sector workers receive.




Japan’s debt is 229% of GDP.  They are considering increasing taxes.  While normally this is considered to be bad for an economy, one thought is that a plan to increase taxes over time will help to increase inflation expectations (which would be good in Japan’s deflationary environment).  But, as I’ve said many times, 95% of Japan’s debt is owned domestically – and this should prevent a run.




Harvard Professor Martin Feldstein says that we don’t need to worry about inflation in the US. One of his key arguments is that we will not have to print money because we are able to borrow to finance our deficit.  I just don’t understand this argument (which was also made by the ratings agencies).  At some point, investors could decide that they don’t want to finance us.




4. Corporate Governance and Banks

Citi reduces board. Citi is cutting their board from 17 seats to 15.  This is a move in the right direction.  While varied expertise can be helpful, the accountability of smaller boards is important.




I wish your shareholders did so well! Ken Lewis left Bank of America with $83MM in compensation and benefits.




5. Buffett’s Letter to Shareholders

If you want to learn about business, a great thing to read is Buffett’s letters to his shareholders.  (I have my Investments class read a compilation of these letters.)  This weekend, Buffett released his 2009 letter.  You can find it at this link:

http://www.berkshirehathaway.com/letters/letters.html




In the letter, he discusses the beauty of float (in both his insurance business and his derivatives contracts which is effectively selling insurance on the markets), the social compact in the regulated energy business (where the company promises to make huge investments on behalf of the public and the state guarantees a satisfactory rate of return), the fact that Berkshire groups the railroad business with his regulated energy businesses and the difficulties that have existed in his more cyclical businesses (such as housing).




Buffett argued that factory-built homes struggle because buyers don’t qualify for loans that are guaranteed by the government.  As a result, lower income buyers are paying significantly higher rates for their homes.  It will be interesting to see if this jawboning leads to any new legislation.




Buffett talked about a few things that are near and dear to my heart.  These include:

1. the fact that we want LOW housing starts (not high housing starts) – in order to bring the housing market back into balance
2. shareholders at many companies have been killed while CEOs (and sometimes directors) have become wealthy.  He said that CEOs for financial institutions must bear full responsibility for risk management – it can’t be outsourced to a committee.  In addition, he said that CEOs can’t have upside without having some downside.  As I frequently complain, this compensation structure is simply a free call option and it leads to bad behavior.
3. Companies always talk about the price of a target company, but don’t talk about the value of their own stock.  In other words, if a company’s stock is undervalued (e.g., trading at $15 when it’s worth $25) and the company issues that stock in order to acquire a company that is only slightly undervalued, the Acquiror loses.  He never mentioned the words “Kraft” or “Cadbury”, but he didn’t have to.  It reminds me of when I overheard Jenny on the phone talking about “worthless husbands” but she never mentioned me specifically…

One of the most important things that Buffett said was in his final paragraph – and he says this all the time.  He said that he was lucky to be born in America and lucky to be born with a “business gene” that is rewarded disproportionately to those who have contributed much more to society.  Buffett frequently says that we won the lottery when we were born in the US – and that’s the truth.  In addition, when you compare the work of business or investing relative to doctors or people who have provided us with infrastructure, it’s incredibly disproportionate to think about compensation.  (Of course, if we start thinking about being paid based on contribution to society, it makes me think that the majority of lawyers should have negative income.)




6. Recognizing Turning Points

For those of you interesting in armchair economics, take a quick look at this article written by Donald Luskin, chief investment officer of Trend Macrolytics:

http://www.smartmoney.com/investing/economy/some-ominous-economic-signs/




Luskin revisited the indicators that led him to conclude that the recession ended in May and why some of these indicators are scaring him again (but only slightly). The key ideas:

1. The top in initial claims for unemployment benefits was in April and that always means that a recession is a month or two away from being done.  On the bad news front, wile the four-week moving average is currently 28% below its peak, it has moved higher in the last few weeks.
2. Consensus earnings expectations for the S&P 500 turned last April.  Unfortunately, these expectations are now growing at a slower pace.
3. Credit spreads fell by May.  Again, these have slightly headed up.  Similar to credit spreads, the dollar reached a top in March (when investors were scared, they bought dollars).  The dollar fell sharply after that.  Again, the dollar has been rising during the last few months.

Best signs of recession:

1. inverted yield curve (10 year UST lower yield than 3 month UST or the Fed Funds rate)
2. annual rate of change falling below zero for the real (inflation adjusted) monetary base

7. Random

Toyota accusations continue. The chairman of the House committee investigating Toyota said that the company withheld records in past court cases and engaged in a “systematic disregard for the law.”  These documents related to rollover cases.




Did you see Apolo Ono? Apolo was disqualified in the 500 for pushing some other skater.  After the race, he said that he thought that he was disqualified because the judge was Canadian and he pushed a Canadian.  Bob Costas later said that Apolo was gracious (because he had a smile on his face while he was whining).  I’m not sure how you could watch the race and think that he comes off as anything but a jackass.  In my opinion, he clearly pushed the guy.  Then, to make those accusations…totally absurd.  And since I’m talking about him, it really frustrates me to hear his medal count mentioned in the same breath as guys like Dan Jansen.




I’ll miss the Olympics! If you haven’t figured it out, I love the Olympics, particularly the real sports. Sunday’s hockey game was a great game. It was interesting to hear people say that the game might be the most important sports victory in Canadian history. If that’s the case, the right team won. I don’t think we would have cared that much. I thought our team played great, but you can’t compare this to 1980 when we had amateurs beating the Soviet professionals.

Gatorade canned Tiger as their spokesman. They decided that he was quenching his thirst in other ways.  I think that this was a very simplistic solution to their problem.  I think that they would have been a ton better off shooting some commercials where he hurriedly comes out of a hotel room, downs some Gatorade and rushes back into the room.  The door shuts, the narrator says “quench your tiger” and Gatorade appears on the screen.
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