Wednesday, July 31, 2019

Sox to Bond Ratio

I guess there is no one to blame
We're leaving ground
Will things ever be the same again?
It's the final countdown

Never heard of the SOX to Bond ratio, nor do I know what comprises the 'bond' component. But the ratio of SOX (Philly Semiconductor Index) to a broad measure of bonds suggests some froth in the semis.

Last time the SOX:Bond was this high: the peak.

Tuesday, July 30, 2019

Price-to-Earnings Ratios

Balian of Ibelin: How much is Jerusalem worth?
Saladin: Nothing...Everything!
--Kingdom of Heaven

In a recent post we stressed the importance of valuation. Valuation is the process of estimating how much a security is worth, and comparing that estimate to the current market price.

If you are thinking about buying a particular stock, then valuation helps you answer this question: "If I buy this stock, am I getting a good deal?" As with any purchase, you'd rather not overpay. Valuation helps you get 'the most for your money.'

Many valuation methods exist. For stocks, the most popular one is expressed by what is called the price-to-earnings ratio. The price-to-earnings ratio, or 'P to E,' compares the current share price of a stock to its annual earnings (or net income) per share.

P/E = current stock price per share / annual net income per share

Let's demonstrate. Last week I noted that one of my favorite 'anchor' positions is Johnson & Johnson (JNJ). What is JNJ's current P to E? Price is the easy part. JNJ is quoted at about $132/share this morning.

To find JNJ's earnings, locate the company's income statement for the most recent fiscal year. For the year ending 12/31/18, JNJ reported net income (or earnings) of about $15.3 billion. Currently JNJ has about 2.66 billion shares outstanding. Therefore, earnings per share = $15.3 billion / 2.66 billion shares = $5.75/share.

JNJ's price-to-earnings ratio, then, is $132 / $5.75 = 22.9.

Usually, you won't need to grind out these calculations in your everyday investment research. P/Es are such popular metrics that most investor info sites include them as standard fare.

There is no hard-and-fast rule about what constitutes a 'good' price-to-earnings ratio. However, studies suggest that over long periods (i.e., many decades) of time, the average P/E of the S&P 500 is about 15. All else equal, when stock prices go up, then the P/E increases, implying that valuations are richer or more expensive. Conversely, when stock prices go down, then the P/E declines, implying that valuations are cheaper.

Currently, the PE ratio of the S&P 500 stands at about 22.4, suggesting that stocks as a whole are generally pricey compared to long term averages. On a relative basis, JNJ's P/E calculated above appears to be in-line with the rest of the market.

Although price-to-earnings ratios can be useful, they have several drawbacks--all of them related to the estimate of 'E' in the denominator. Net income figures have often been subjected to accounting tricks that render them inaccurate measures of true cash earnings power. Moreover, analysts often report P/Es on a 'forward' basis, meaning that they use earnings estimates for the coming year rather than actual earnings from the past. This practice complicates interpretation of the metric. Finally, using earnings estimates for a single year does not capture the dynamic cash generating potential of a company over a multitude of future years (which is what you really would like to know).

Despite the warts, price to earnings ratios are good places for investors to begin their valuation analysis.

position in JNJ

Monday, July 29, 2019

Hamilton's Play

"I've been played like a grand piano by the master, Gekko the Great."
--Bud Fox (Wall Street)

In late July of 1789, the state of New York held its constitutional convention. Ratification by New York was not necessary for the United States to come into being, as the Constitution had already been approved by ten states by the time New York representative met. Only nine 'yes' votes were required.

Instead, the state convention essentially became a referendum on whether New York would join the union.

There was opposition. Drawing from the Antifederalist argument, many worried that the central government would grow too big and powerful, thereby marginalizing state sovereignty.

Nonsense, said one of the greatest proponents of strong central government--New York's own Alexander Hamilton. The co-author of the Federalist Papers addressed the convention:

"Gentlemen indulge too many unreasonable apprehensions of danger to the State governments. They seem to suppose that the moment you put men into a national council, they become corrupt and tyrannical and lose all their affection for their fellow citizens. But can we imagine that the Senators will ever be so insensible of their own advantage as to sacrifice the genuine interest of their constituents?"

The Antifederalists certainly imagined it. And it is difficult to argue with the prescience of their vision.

It is also difficult not to surmise that Hamilton was being at least a tad disingenuous with his esteemed colleagues at the state convention. After all, the ink was barely dry after the state signing before he began arguing that the Constitution contained implied powers that granted the federal government greater authority over the states. Post Constitution, Hamilton became perhaps the most vocal proponent of strong central government.

Did the delegates at the New York ratification convention realize that they were being played?

Sunday, July 28, 2019

New Moon

Fill my heart with song
Let me sing forever more
You are all I long for
All I worship and adore
--Frank Sinatra

Looking back to that first lunar landing and moon walk 50 years ago, it is easy to wonder just how we did it given the state of technology at the time.

Oh, yes. We can be certain that if that mission were being flown today, things would be very different...

Saturday, July 27, 2019

Since Yesterday

"Screw FDR, screw Hoover. They're all the same. I come home one day I'm standing in my living room, and between the mortgage and the market and the goddamn lawyer that was supposed to be working for me, it stopped being mine. It all stopped being mine. FDR hasn't given me my house back yet."
--Mike Wilson (Cinderella Man)

After the Fed's ill-conceived actions to achieve general price stability during the 1920s brought on the Great Depression, the correct response would have been to get out of the way and let prices fall to permit market excesses to clear.

Unfortunately that is not what occurred.

1934-S 50c PCGS MS66+ CAC

Many New Deal policies, initiated by the Hoover administration and then escalated by FDR, sought to maintain prices at artificially high levels. Wage rates, commodity prices, you name it. Programs came out of the woodwork to restrain market forces from taking prices where they needed to go: lower.

Paradoxically, many onlookers understood that these price stability policies were ill-conceived--even if these people were committed New Dealers. For example, Frederick Lewis Allen, a journalist who penned what in my view was an even-handed review of the 1920s, betrayed his neutrality with a sequel about the 1930s (Allen, 1939) that was clearly sympathetic toward the New Deal. Despite his bias, however, Allen did admit several times during the book that the interventionary policies did not seem to be working. Unusually high unemployment persisted. Private investment remained stubbornly low. Prosperity had not returned.

1937-S 50c PCGS MS66+ CAC

At one point, Allen explained the problem this way:

"Throughout the early years of the New Deal the levels of prices and wages and the structure of corporate and private debt were being artificially supported by government spending...If it had been possible for the law of supply and demand to work unhindered, prices and wages--and the volume of corporate and private debt--would theoretically have fallen to a 'natural' level and activity would have been resumed again. But it was not possible for the law of supply and demand to work unhindered. In a complex twentieth-century economy, deflation was too painful to be endured. Hoover had set up the RFC because banks couldn't take it; Roosevelt had set up the Federal relief systems because human beings couldn't take it." (223)

1939-S 50c PCGS MS67+ CAC

Near the end of his work, Allen pondered the economic malaise that endured into 1939:

"Must America at last be reconciled to the dictum that as its population growth slowed up it economic growth must slow up too? Must it accept either a continuance of this twilight prosperity, with the burden of carrying the unemployed becoming progressively greater, or else a grim deflation of prices and wages and debts till the labor surplus could be absorbed--a deflation which might be even less endurable than that of 1929-33? No one could relish either of those prospects." (334)

Allen and others knew what was needed. But they couldn't take the pain associated with letting markets clear.

That same pain avoidance policy--euphemistically labelled  price stability--endures Since Yesterday.


Allen, F.L. (1939). Since yesterday. New York: Harper & Row.

Friday, July 26, 2019

Who Likes High Prices?

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis and the News

Phillips et al. (1937) convincingly argue that the Federal Reserve was seeking to stabilize general prices at an artificially high level during the 1920s. But who was the central bank trying to placate with this policy? As of yet, the Fed had no formal 'price stability' objective.

The everyday consumer certainly does not clamor for higher prices. Always and everywhere, the average person welcomes lower, not higher, prices in order to extend purchasing power and standard of living. And that is what should occur in unhampered markets as improved productivity thru capital investment puts downward pressure on prices.

Who, then, benefits from prices being propped up? Several groups come to mind.

Inefficient and uncompetitive businesses. It is easier to manage operations when selling prices are high. Environments that exert downward pressure on prices require more capacity for innovation and efficiency. When prices are artificially kept high, less entrepreneurial energy is required.

Leveraged entities. Entities carrying lots of leverage dread lower prices. If you've borrowed money to buy or produce balance sheet assets, then declining price environments threaten your solvency. The value of assets declines while debt values remain constant. Equity gets thinner and, if prices decline enough, you're upside down and busted. Banks are classic examples here. In the 1920s, farmers constituted another large group with a powerful lobby.

Bond sellers. Governments and businesses that want to sell debt can sell to non-economic buyers when central banks are in the market buying via their 'open market operations.' Bond sellers can sell their paper at higher prices and at lower coupons than they otherwise could.

The Fed itself. Legitimacy increases for a central bank that it can manipulate market prices. Moreover, central planners that possess the control gene may not be able to restrain themselves from meddling in monetary affairs.

It is likely that various institutional forces were influencing Federal Reserve actions to prop up prices during the 1920s. Those pressures remain with us today.

Thursday, July 25, 2019

Boxing Match

"You stop this fight, I'll kill ya."
--Rocky Balboa (Rocky)

When stocks begin a secular liftoff they often follow a pattern attributable to 'box theory.' Sideways movement punctuated by breakouts to a new range (shaped like a box) on big volume.

Pan American Silver (PAAS) has shown early signs of this pattern. After bottoming at a 52 week low in late May, the stock jumped higher on big volume. It has since jumped two more boxes higher, also on big volume.

This is classic technical action associated with new attention being paid to a stock that is now under accumulation.

Am looking to add to my position should the stock retrace a bit in the current box.

position in PAAS

Wednesday, July 24, 2019

Real Thing

I'd like to buy the world a home
And furnish it with love
Grow apple trees, and honey bees
And snow white turtle doves
--The Hillside Singers

Classic example of the bi-polar nature of markets. Six months ago investors dumped Coca-Cola (KO) shares after its earnings report after concerns about the future of soft drink consumption.

Fast forward to this week's quarterly earnings report. Similar results garner a collective cheer, and the stock gaps to all time highs.

Which view is the Real Thing?

position in KO

Tuesday, July 23, 2019

Taxable or Tax-Deferred?

Let me tell you how it will be
There's one for you
Nineteen for me
--The Beatles

Since the advent of individual retirement accounts (IRA) and 401(k) employer-sponsored retirement plans over 30 years ago, financial planners have been promoting these 'tax-deferred' investment accounts as the primary vehicles for accumulating retirement resources.

Tax-deferred accounts do have benefits. Each year, individuals can contribute funds, up to a limit, to an IRA or 401(k) 'before tax,' meaning that contributions are subtracted from your paycheck before income taxes are calculated. Moreover, gains from capital appreciation and dividends that accumulate in these accounts are tax-deferred, meaning that account holders do not pay taxes on these gains until withdrawals are made--presumably far down the road during retirement. An additional benefit of 401(k)s is that employers often match a percentage of employee contributions up to a particular limit, offering what essentially amounts to a salary bump for participating employees.

Tax-deferred accounts do carry disadvantages, however. Tax-deferred does not mean tax-free. When individuals do withdraw from IRAs and 401(k)s--and they are legally required to begin doing so by age 70 1/2 if they have not done so sooner. Those distributions are then subject to ordinary income tax. While it is often assumed that individuals will be in lower income tax brackets by the time they retire, the reality is that future tax rates are uncertain, and an argument can be made that future tax rates could be considerably higher depending on the political climate. For instance, higher tax rates might be deemed necessary down the road to fund our burgeoning and ever-increasing federal debt.

One way to reduce this risk is to open what is known as a Roth IRA. Contributions to Roth IRAs are done 'after-tax.' meaning that you pay income taxes upfront on your contributions. Because you've paid taxes on the front end, withdrawals subsequently made during retirement are not subject to further taxes. For many people already involved in saving for retirement using the above-mentioned tax-deferred vehicles, however, Roth IRAs tend to be viewed as more of a supplemental vehicle for wealth-building. Roth IRAs are also subject to future political risk that could reduce or even eliminate the tax benefit.

Perhaps the largest disadvantage associated with tax-deferred accounts is loss of financial flexibility. Once you contribute to an IRA or 401(k), you lose access to those funds for a long period of time. If you want to withdraw from a tax-deferred account before you are legally permitted to do so, then you must pay a substantial penalty. Early withdrawals from a 401(k), for instance, are commonly subject to a 10% penalty in addition to the income tax burden.

The commitment that accompanies tax-deferred investing creates a strange (and risky) situation. Conceivably, you could be socking away lots of excess income in IRAs and 401(k)s yet have insufficient savings available to fund life in the present. By tying up economic resources in tax-deferred vehicles, you can compromise capacity for living in the here-and-now. Your financial flexibility declines.

Can you see that one explanation for rising household debt loads over the past few decades is the diversion of too much income toward IRAs and 401(k)s--which has left these people with insufficient  savings for funding everyday expenses? Borrowing has been necessary to make ends meet.

So how did people save for retirement prior to IRAs and 401(k)s? Some employers offered 'pension' plans that promised employees a pre-determined monthly retirement income based on years of service. Most of these 'defined-benefit' plans are being phased out in favor of the 401(k) 'defined-contribution' design. Of course, not everyone worked for employers with rich pension plans. How did they save?

They simply used taxable vehicles. For everyday savings they kept money in checking and savings accounts. Lots of money. High balances in these accounts allowed funding everyday expenses while still saving for the future. For people seeking more potential return on their capital, then they could open taxable brokerage accounts to enable purchase of stocks, bonds, and other risky assets.

Use of taxable saving and investment vehicles permitted previous generations to remain financially flexible. They could comfortably provide for the present while saving for the future in a direct, uncomplicated manner.

Today's focus on IRAs and 401(k)s has reduced awareness of the benefits from taxable saving and investing. In a future post, we'll discuss advantages of taxable brokerage accounts in more detail.

Monday, July 22, 2019

Inflation and the Gold Standard

Revvin' up your engine
Listen to her howlin' roar
Metal under tension
Beggin' you to touch and go
--Kenny Loggins

While absorbing the Phillips et al. (1937) study, I was struck how much money can be created inside a banking system (governed by a central bank) despite the purported 'limitations' of the gold standard. During the 1920s, the USD was still backed by gold to the extent that people could still trade dollars for gold.

Yet central banking policies facilitated the inflation of total quantity of money (particularly credit money) by orders of magnitude while the Twenties 'roared.'

Yes, several factors were working on the monetary system at the time, including some outside the US, that served to confound (and perhaps obscure) the dollar:gold relationship.

But the point is that a gold standard, by itself, does not prevent inflation of the money supply into the danger zone.

position in gold

Sunday, July 21, 2019

Price Stability

Face to face
Each classic case
We shadow box and double cross
Yet need the chase

Phillips et al. (1937) present compelling evidence that the primary objective behind the Federal Reserve's fateful financial market interventions during the 1920s was to stabilize general prices at some level that the institution thought appropriate. Included are several statements from Fed officials during the period that reflect a price stability motive.

But why should these researchers expend such effort to present the obvious, I wondered? Everyone knows that one of the Fed's charters, as poorly executed as it as been, is price stability.

It turns out, however, that the central bank was assigned no such mission in the original Federal Reserve Act of 1913. Developed largely in reaction to the Panic of 1907, the original Act created the Federal Reserve primarily to govern national banking operations and to serve as the 'lender of last resort' in times of market stress.

No explicit monetary policy objectives appeared in the original Act. They were added later as an amendment in 1977. These policy objectives empower the Fed "to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates." [emphasis mine]

The price stability motive, then, has been a consequence of mission creep at the Fed.

Of course, most people have been conditioned to think that price stability is a good thing. After all, who should oppose consistent, predictable prices in the marketplace?

You and I, if we were smart.

In unhampered markets, the natural direction of prices is down. As Phillips et al. (1937) point out several times in their analysis, productivity improvements funded by investment capital create more goods over time. More goods spread over a constant amount of money means lower unit prices.

As productivity improves, prices go down and purchasing goes up.

People pounding the table for stable prices (much less the 2% price increase currently promoted by the Fed) effectively seek to rob you of purchasing power. They want to raise your cost of living.

Who would want to do this? Who would want prices to be higher than they otherwise have to be? We'll consider this question in a future post.

Saturday, July 20, 2019

Banking and the Business Cycle

"Never had my house pushed over before. Never had my family stuck out on the road. Never had to lose everything I had in life."
--Ma Joad (The Grapes of Wrath)

Ten years ago I began a book about the causes of the Great Depression called Banking and the Business Cycle (Phillips, McManus & Nelson, 1937). With my renewed reading campaign about the 1920s and 1930s this summer, I recently finished this insightful work.

The backdrop is compelling for several reasons. The authors are three professors who conduct their analysis with requisite academic rigor. Footnotes and data abound. The analysis focuses on monetary-related causes of depression. Findings are integrated to formulate a general theory of business cycles that goes beyond the Depressionary period. Finally, the book was written while the Depression was still at work. Similar to the recently completed Allen (1931) work, publication inside the period adds freshness and validity that later work can't replicate.

Their analysis points directly at that policies of the Federal Reserve--policies enacted during WWI and in the following decade--as causing the depth and length of economic malaise that characterized the Depression. The Federal Reserve Act was passed in 1913, a couple of years before WWI began. Relaxed parameters of the newly created central banking system (e.g., lower reserve ratios, member banks needed to deposit all reserves with Federal banks, low Federal Reserve bank reserve ratios, lower reserves required for time deposits) expanded credit creation capacity orders of magnitude greater than what was possible pre-Fed. This enabled US WWI operations to be funded primarily through the sale of government bonds that were purchased primarily by the banks. As is usually the case when war is funded by inflationary policies, prices generally increased during this period

Following the war, market forces naturally worked to correct the systemic distortions. A general deflation commenced to destroy excess credit and decrease prices. (The authors present interesting data indicating that during the two prior US wars--the war of 1812 and the Civil War), prices generally returned all the way to their pre-war levels and then some). Much of this deflation occurred during the deep but relatively brief Depression of 1920-1921.

Coming out of that depression, however, prices had only retraced about 50% of their wartime increase. This is when the Fed began a multi-year campaign to intervene in the name of 'price stability.' In 1922 the Federal Reserve embarked on the first of three rounds (they did similar in 1924 and 1927) of lowering what today we call the 'Fed Funds rate' and engaging in 'open market operations' (read: bond buying) that, coupled with the central banking system's newfound capacity for pyramiding credit through the system, created the leveraged fuel that funded several rounds of speculative investment--first in productive capacity, then in real estate, and finally in stocks--that inflated the bubble that ultimately popped with the market crash of 1929.

It is interesting to note that prices of goods and services did indeed stabilize. Despite all of the credit creation, prices of consumer goods did not change much and never reclaimed pre-WWI levels. However, prices of speculative assets such as real estate and stocks went through the roof. Although the authors did not call it such, they explain this phenomenon as if it were the Cantillon Effect. The newly created credit largely remained within the financial system, and the first users of the newly created credit bid up the prices of financial assets accordingly.

Those who cannot recognize the parallels to our present situation are not engaging their brains.

Post crash, the authors considered why economic activity persisted at such depressed levels. Their explanation centered on New Deal policies, many initiated during the Hoover administration, that extended the previous decade's price stability motive via additional rounds of monetary and fiscal policy. They make a particularly compelling argument that restricting layoffs and legislating minimum wage rates essentially institutionalized widespread unemployment. Letting labor markets clear at much lower wage rates, in authors' view, was the quickest way to end the Depression.

I was longing for a deeper dive into the effects on savings during the period. What happened to savings rates during the 1920s? And if savings were sharply lowered during the boom, then how could the economy expand significantly until those savings had been replenished? A rigorous discussion of the interaction between credit creation and real savings would have been icing on the cake.

That said, this is a superior analysis with few peers. An amazing work from individuals who were still living the times.


Phillips, C.A., McManus, C.F. & Nelson, R.W. (1937). Banking and the business cycle. New York: The Macmillan Company.

Friday, July 19, 2019

Anchor Positions

We thought just for an instant
We could see the future
We thought we once knew
What really was important
--Til Tuesday

As a long-term investor, I like to build my stock portfolio around a handful of 'anchor' positions. Anchor positions are shares of companies that possess characteristics that I really like: proven track record, strong management, wide moats, and solid dividends.

To design diversification into my portfolio, I seek anchors from various industries. Sectors from which I prefer to source my anchors include healthcare, consumer products, retail, utilities, finance, info tech, and energy.

Anchor stocks provide the foundation for my stock portfolio. I might add other names over time, but I begin with the anchors. Moreover, I tend to allocate more capital to my anchor positions than to others.

To demonstrate (and NOT to be construed as advice), my favorite anchor stock for many years has been Johnson & Johnson (JNJ). It possesses the qualities that I prefer, including more than 100+ yrs of operation in the healthcare sector (spread evenly across pharma, medical products, consumer health), infamous corporate culture, 50+ yrs of consecutive dividend increases.

There are risks, of course. The company is currently involved in several lawsuits concerning its products. Longer term, political interest in health care casts a large shadow of uncertainty across the entire sector.

The technical picture shows the stock price near a level of support touched several times over the past year. I've recently added a bit to my position around this price. Currently, JNJ constitutes my largest stock holding.

One more thing about anchor positions. As the name implies, anchors don't move--not without intention, at least. When I take on an anchor position, my intention is to hold it for life and then, hopefully, to pass it along to the next generation.

position in JNJ

Thursday, July 18, 2019

Silver Streaking

Caught up in the action
I've been looking out for you
--Glenn Frey

Silver starting to streak. First time it's outperforming gold in some time.

Bodes well for the entire complex.

position in gold, silver

Wednesday, July 17, 2019

Playground Retro Channel

This summary is not available. Please click here to view the post.

Tuesday, July 16, 2019

Bulls and Bears

"Blue Horseshoe loves Anacott Steel."
--Bud Fox (Wall Street)

Nearby the New York Stock Exchange in downtown Manhattan sits the Charging Bull, an enormous bronze statue meant to symbolize American can-do spirit, particularly that of New Yorkers. Its placement in the Financial District is no accident, as 'bullishness' has been a hallmark of the sentiment that drive Wall Street.

If you are bullish, then you are optimistic. You think prospects are good and prices are bound to go higher. Bullish behavior tends to power markets higher over time.

Opposite of the bulls are the bears. If you are bearish, then you are pessimistic. You think prospects are bad and prices are going lower. Bearish behavior tends to power markets lower over time.

How did the bullish and bearish terminology come about? No one knows for sure. One theory relates to how these two animals attack opponents. Bulls tend to thrust their horns up in the air, while bears tend to swipe down, thus creating metaphors for up and down price behavior in markets.

Because human beings tend to be optimistic by nature, bullish sentiment tends to weigh heavily on financial decision-making. It is also celebrated. It probably should not be surprising that there is no bear statue standing near the Charging Bull in downtown New York.

The bull/bear symbolism carries important implications for investors. One is to recognize that human tendency toward optimism will naturally make you--and others--bullish. Financial markets thrive on bullish sentiment, the purchase of securities, and the higher prices that go with it.

Natural tendency toward bullishness, however, means that we tend to overlook the downside of investment decisions. It can be hard for us to recognize and factor in the risks.

Recognizing these implications, investors can improve their decision-making. Suppose that you are interested in buying Verizon Communications (VZ) stock. As a bull, you think VZ stock is a good deal here. But in order to buy VZ stock, someone else must be willing to sell shares to you. Why is the seller bearish? Before you buy, it is a good idea to do some research. Explore the bearish arguments. What are the reasons for selling VZ rather than buying it? By comparing the bearish arguments to your bullish ones, you have created the basis for a more balanced, informed decision.

A smart cookie I know likes to call this "seeing both sides of the trade." To me, it seems like critical thinking.

position in VZ

Monday, July 15, 2019

Warehouse Banking

"I'd prefer that nobody ever touch my safe deposit box. Not them, not you, not the authorities. And the sooner this situation ends, the happier I'll be."
--Arthur Case (Inside Man)

The earliest banks began as money warehouses. Entrepreneurs created safe places for people to keep their money and other valuables secure. The business model was simple. Bankers would charge a fee to store and safeguard depositor property. The fee was based on the value of the property and the time that it was stored.

When they dropped off their property at the bank, depositors got a 'warehouse receipt' signifying that the bank had control of their property. When they wanted to withdraw their property, depositors would present their warehouse receipts at the desk and bank employees would retrieve the valuables from the vault or other safe space.

The primary risk of this model was loss of property while stored at the bank (e.g., bank robbery, fire, etc.). This risk was borne primarily by the depositor unless a) it could be shown that the bank itself had stolen property under its management or b) part of the original contract involved the bank's promise against property loss. In the case of b), the bank would have to insure its business either by self-insuring or buying a policy from a third party insurer. Still, if the insurance policy could not cover claims, depositors were left high and dry.

A good example of the warehouse banking model still exists today in the form of safe deposit box operations at a bank. Lock boxes of various sizes are available for customers to rent. Because these boxes are usually located in the bank's general vault, they are deemed very secure. However, the lease agreement that the renter signs up front absolves the bank from liability should the property be lost from theft, weather events, et al. (unless, of course, it can be shown that theft was an 'inside job').

Because the renter of a safe deposit box sees the bank as a secure storage facility--more secure, say, than the mattress back at the homestead--then the risk of loss is perceived as relatively low, and the money warehouse banking model can thus offer value to the marketplace.

As we know, however, few if any banks operate solely in this manner today. Enterprising bankers have found other ways to leverage (quite literally) this business model. We'll discuss how the return prospects of money warehouses were ratcheted up in a future missive.

Sunday, July 14, 2019


"Casey, this is the biggest thing that could happen to any of us. It means a B-29 command!"
--General Clifton I. Garnet (Command Decision)

Heard the droning engines this am but couldn't find it initially...

...then saw it circling toward me from the south...

...spreading its wings over the trees and homes...

...a B-29 Superfortress...

...the largest Warbird of WWII...

..wheels down and heading for home.

I looked around at the people walking the sidewalks, They didn't seem to notice.

Saturday, July 13, 2019

Silver Setup

We've always had time on our sides
But now it's fading fast
--Orchestral Manoeuvres in the Dark

As the Fed signals that it has the market's back and stocks celebrate with daily record highs, I can't help but think the precious metals may be ready for an epic run. I particularly like silver as it is likely to outperform gold if things really get going to the upside.

ETFs such as SLV and CEF are ways to get exposure to the silver metal itself. There are also a few silver miners that act as leveraged plays on the underlying metal. Pan American Silver (PAAS) has long been my favorite name here. Over the past year, general malaise for silver combined with concerns about a big acquisition have locked the stock in a downtrend.

Price action has firmed recently, however, and put PAAS at an interesting technical juncture. The share price sits just below both the 200 day moving average and the year-long downtrend line. A small flag pattern also appears to be approaching resolution right around here.

Needless to say, breaking through these various expressions of resistance would be technically significant and bullish. I like this setup and will look to add to my position early in the week.

position in gold, silver, CEF, PAAS

Friday, July 12, 2019

Only Yesterday

"He used to be a big shot."
--Panama Smith (The Roaring Twenties)

Just completed Only Yesterday, a book by Frederick Lewis Allen that chronicled life during the 1920s. Allen was a journalist and magazine editor. When this book was published in 1931, he was writing for Harper's magazine.

The 1920-1930 period of US history interests me. Although I have read several books on this era already, Allen’s work promised to be an attractive read. As a mainstream journalist, Allen offers relaxed social perspective that differs from the rigorous analysis of academic economists that dominate literature about this period. Because the book was published soon after the decade ended, Allen's perceptions were still fresh in his mind and less subject to loss of accuracy from time decay. The quick turnaround also reduces the chance that the fidelity of his analysis was influenced by conclusion reached by future 'authorities' of the subject.

1922 $20 PCGS MS65+ CAC

The primary strength of this book is the analysis of social trends during the 1920s. The effect of WWI and Wilsonian regime on behavior (live for the day, less idealism, less tolerance for long, drawn out issues and news events). Women's fashion (skirts shorter, less frills, flat profiles, short hair, helmet hats). Youth rebellion and disillusionment (discarding customs and ethics, freedom facilitated by automobile, sex over love, alcohol consumption). Unfolding technologies (radio, car, airplanes). Fascination with 'ballyhoo' (Linbergh, murder cases, sports). Prohibition (going thru the rigorous process of passing a law by Constitutional amendment and then collectively ignoring and/or breaking it).

Several times I found myself tingling with a sense of deja vu. During Allen’s recount of the Red Scare in the early part of the 1920s, for instance, the rush to judgment and denial of rights toward those deemed communists or communist sympathizers seemed mirrors other targeted groups experience today.

1923-S $1 PCGS MS65 CAC

The most eye-brow raising 'never knew that before' data point? The theory that President Warren Harding didn't die from illness in 1923. Rather he either a) committed suicide upon learning of  Teapot Dome and other scandals committed by people in his administration, or b) was murdered (likely poisoned) by his wife when she learned of his extra-marital affairs which allegedly produced at least one child.

Allen focuses on the market bubbles toward the end of the book. Real estate comes first, primarily because the excitement came and went a bit earlier in the decade. The housing bubble in Florida and elsewhere was inflating by 1925 and had largely popped three years later.

1926 $20 PCGS MS65 CAC

Rather than dying there, the speculative juices of America then turned toward to stocks. Although equity markets had been rising steadily through much of the decade, it was not until 1928 that the real stock market action kicked in. Despite big time volatility that included at least four white knuckling pullbacks, stocks commenced an epic rise over the better part of the next two years.

Allen does well in capturing the accompanying sentiment. Stories of cab drivers and waitresses speculating in Steel (US Steel) and Radio (RCA). Bullish prognostications of Wall Street gurus and many academics.

1927-S $1 PCGS MS65 CAC

He also emphasizes the impact of margin loans. People everywhere were buying stock on margin. Even when the Fed announced in 1928 that it would not lend to entities supporting 'speculation,' margin loans continued to grow. Where did this credit come from if it was not facilitated by central bank credit? Perhaps it still did but in a roundabout way. Much capital for margin loans came from corporations that saw opportunity to make a tidy sum by lending cash to banks for the margin crowd at 10% or more.

As hoped, Allen zeros in on the panic during the fall of 1929. In late October he offers a day-by-day synopsis of what occurred around Black Tuesday. The most insightful aspect of his account: how far behind information systems were at generating data that today we take for granted--such as real time stock quotes. During the height of the panic, quotes were hopelessly behind--3-4 hours minimum. Imagine trying to decide whether to hold onto a margined position when you have no idea where prices are. Clerks settling trades burned the midnight oil for weeks to complete the accounting. Margin calls went out sometimes days late.

1928 $20 PCGS MS66+ CAC

What Allen doesn't address, and frankly I did'nt expect him to, was the role of monetary policy during the decade (and earlier) in facilitating the speculative fervor of the Roaring Twenties. People are always looking for a quick buck but they don't always have access to the means (read: easy credit) to satisfy their speculative urges. Where did those means come from during the 1920s? Allen is silent in that regard.

At the end Allen recounts the aftermath. In his view, the Hoover administration's efforts to get 'prosperity' back on track weren't working. Optimism was turning to pessimism. Business investment was falling. Unemployment was rising. Thoughts about the benefits of socialism that had waned with the Red Scare ten years earlier was gaining traction once again. Considering that the election of 1932 was still a year or so away, the picture that Allen paints in the year or so following the Crash suggests an interesting (and accurate) trajectory.

It turns out that Allen followed this work up with a chronicle of the 1930s, Since Yesterday. I've just opened it.


Allen, F.L. (1931). Only yesterday. New York: Harper & Row

Thursday, July 11, 2019

Late to the Avalanche

Oh it's too easy to live in a cold sweat
Just sitting dripping in pools below
You can wipe your face
Kill the pain
But the fever won't go, no, no

Right on cue from our earlier post, it seems the Pomboy girl is also experiencing some deja vu back to 2007. Back then, while the Fed was cutting rates at stock market highs, the central bank's actions were not preemptive in the least. Instead, the Fed was unable to get ahead of the subsequent avalanche of widening credit spreads.
Now, we have record debt, much of it low (read: junk) quality, getting ready to roll in record quantities.

Is the Fed once again late to the avalanche, as Steph suggests?

Rate Cuts at Market Highs

'Cause she's so high
High above me
She's so lovely
--Tal Bachman

Major US equity indexes are marking all time highs after Fed chair Jerome Powell's dovish speech in front of Congress yesterday seemed to guarantee that the FOMC will cut rates at its upcoming July meeting. That the Fed plans to lower interest rates with markets at all time highs has raised more than a few eyebrows.

But such a move is not unprecedented. In the fall of 2007 the Fed cut rates three times to bring down the Fed Funds Rate a full percent from 5.25% to to 4.25%. Stock markets proceeded to rally to all time highs during this period.

The euphoria was short-lived, of course. The following year saw markets absorbing the full effects of the credit crisis. The SPX would fall more than 50% from those rate cut highs. In fact, the Fed furiously cut rates in 2008, lowering the Fed Funds all the way down to an astonishing 0.25% by December.

By that time, markets  no longer celebrated the cuts. Instead, they plummeted lower.

History suggests that caution, not euphoria, is sometimes warranted when the Fed cuts rates at all time stock market highs.

Wednesday, July 10, 2019

Gamma Trap

"Well, gentlemen, the players may have changed but the game remains the same, and the name of that game is 'Let's make a deal.'"
--Jack Trainer (Working Girl)

Interesting article in WSJ (discussion here) seeking to explain why we often get long periods of low volatility punctuated by sharp selloffs. The theory centers around the use of derivative-centered products that investors are purchasing to squeeze out extra income in a yield-starved world, and the hedging that dealers who take the other side of this trade must do.

Over the past several years, conditions of financial repression have found investors reaching for yield in increasingly exotic, and risky, ways. One way is to sell out-of-the-money puts. To sell (or short) a put, an investor borrows the option from a dealer, sells it, and collects the cash proceeds from the sale. As long as the stock does not decline to the point where the strike price is hit on option expiration day, then the investor happily keeps the cash income.

This strategy has exploded in popularity as suggested by the greater than ten fold increase in SPX option activity since 2011.

The dealer who borrows the put for the client to short is now long a put option or its equivalent in stock. Unless the dealer wants to keep a directional bet on its books, then it must go long some stock to hedge.

However, this hedging is not a one-time thing.

A characteristic of options is that someone who is long an option gets longer as the price of the underlying stock approaches the strike price. In options speak, 'gamma,' or the rate of change in the price of the option, goes up as the underlying price approaches the strike. As such, dealers who are counterparties in the above short option trade must continually hedge as stock prices change.

Because dealers are long put options in the trade, an unanticipated decline in stock prices suddenly finds extra gamma on the hedge book that dealers generally don't want. To offset the gain in gamma, dealers buy stock or futures to compensate.

As put selling strategies have increased in popularity (see above chart), the effect on markets is to put a bid under stock prices whenever they suddenly decline, thereby suppressing volatility and, perhaps, lulling investors into a false sense of security.

The graph above indicates the effect. The longer the gamma, the more dealers hedge. The more dealers hedge, the lower the range in daily returns. This is sometimes call 'volatility suppression.'

Seems like nirvana, doesn't it? The more market participants short out-of-the-money puts, the more income they get--with seemingly downside protection provided by their dealer counterparties against price declines.

Sensing as you might that there is no such thing as a free lunch, what could go wrong? One possibility is that dealers could get bearish and keep downside gamma on the books rather than hedge it by purchasing stock, thereby removing the underlying bid in a weak tape.

Another possibility is that stock prices gap down to the point where those who are short puts unwind their trades before they go too far awry. They will be tempted to do so because there are few faster roads to ruin than to be short puts in a declining market. Dealers would then work in reverse, short stock to manage gamma on their hedge books.

Market participants might also unwind their short option trade if interest rates rise and other income-producing opportunities reveal themselves.

Meanwhile, markets are coiling like a spring with increased leverage resulting from large derivative trades. The players may may look different, but we've seen this movie before and it does not end well.

Stability, when facilitated by intervention, leads to instability.

Tuesday, July 9, 2019

Determining Portfolio Yield

Claire Dearing: So, you can pick up their scent can't you? Track their foot prints?
Owen Grady: I was with the Navy, not the Navajo.
--Jurassic World

Suppose you had a portfolio of four stocks...

Dominion Energy (D) 8 shares
Intel Corp (INTC) 12 shares
Johnson & Johnson (JNJ) 5 shares
Target Corp (TGT) 7 shares

...and you wanted to determine the dividend yield of your stock portfolio. In addition to the number of shares noted above, you'll need two pieces of info for each position: current share price and the quarterly dividend per share. These are readily found on Schwab or on any financial web site (e.g., Yahoo Finance, etc.). Here's the info (price quotes from this morning and current quarterly div/share):

D          $77.75    $0.9175
INTC   $47.28    $0.3150
JNJ     $141.94    $0.95
TGT     $89.24    $0.66

First find the value of each position and the total portfolio value. Using Dominion (D) as an example:

position value = # shares * price/share = 8 * 77.75 = $622.00

Similarly for INTC, JNJ, TGT, we get $567.36, $709.70, $624.68 respectively. We can sum them all to get a total portfolio value of $2,523.74.

Now, find the annual dividend payout for each position and for the entire portfolio. Again, using D to exemplify:

annual dividend payout = # shares * quarterly dividend/share * 4 * = 8 * 0.9175 * 4 = $29.36

For the others, using same order as before, we get $15.12, $19.00, $18.48 respectively. We can sum them all to get a total annual dividend payout of $81.96 for the portfolio.

Now we can calculate the overall portfolio yield:

Portfolio yield = total annual dividend payout / total portfolio value * 100

In our example, this equals $81.96 / $2,523.74 * 100 = 3.25%

This portfolio's yield is well above the current 2% dividend yield for the S&P 500 overall.

Using a spreadsheet, of course, will streamline this task considerably and make updates easy.

position in D, INTC, JNJ, TGT

Monday, July 8, 2019

Want Peace? Limit the State

"Tonight I will speak directly to these people and make the situation perfectly clear to them. The security of this nation depends on complete and total compliance. Tonight, any protester, any instigator or agitator, will be made an example of!"
--Sutler (V for Vendetta)

Nice quote from Mises. Peace among nations requires smaller states and less state influence.
This is the antithesis of what is occurring.

Reduce state power and that power flows naturally toward the people. War and state-driven violence give way to peace and voluntary cooperation.

Sunday, July 7, 2019

Economic Policy Uncertainty

That's life
Something that
You thought you know but didn't
Call now
Now it's your call
But nothing's for 
--The Apartments

The graph below was pulled from a tweet that caught my eye. I have a research interest in the effects of various forms of institutional uncertainty on operating decisions. Institutional uncertainty has  assorted aliases and dimensions including regime uncertainty, regulatory uncertainty, and, in this case, policy uncertainty.

The graph plots business confidence vs a measure of policy uncertainty. It proposes that rising policy uncertainty dampens business confidence although it is difficult to see that in the graph. Policy uncertainty as measured is pictured as rising throughout the time frame shown--which is interesting in itself. However, there is no obvious corresponding downtrend in business confidence. Also, there is no discernible relationship between policy uncertainty and period of 'global slowdown' (however measured).

Frankly, most interesting to me here is how 'policy uncertainty' is  measured. The tweet cites its source as the Economic Policy Uncertainty Index which can be found here. The authors are three professors, Scott R. Baker (finance prof, Northwestern), Nick Bloom (econ prof, Stanford), Steven J. Booth (international business and econ, Chicago).

The index is constructed from three components. The first component is a normalized index of the volume of articles from 10 large newspapers discussing economic policy uncertainty. The second component is an annual dollar weighted number of tax code provisions scheduled to expire over the next 10 years (a measure of uncertainty about the future path of the federal tax code). The third component is a measure of dispersion among forecasters drawn from the Philly Fed's Survey of Professional Forecasters w.r.t. predictions about future levels of the Consumer Price Index, Federal Expenditures, and State/Local Expenditures (a measure of uncertainty about policy-related macro variables).

This is a manually intensive data series to collect, as reflected by all of the helpers involved. The US data can be downloaded here.

I plan to examine this measure more in the future.

Saturday, July 6, 2019

Organizational Size and Markets

Wouldn't be the first time
That things have gone astray
Now you've thrown it all away
--Bryan Adams

Good discussion by Prof Bylund on organizational size in free markets. Many believe that competitive markets lead to monopoly. In early stages of industrial growth, small firms work hard to out-compete each other thru innovation. As industries mature, however, smaller numbers of firms remain because of mergers and attrition. Scale economies kick in for those still in the game, ultimately leading to monopoly.

Markets must therefore be regulated, so this logic goes, in order to prevent price gouging by large monopolistic firms.

Nobel-laureate Ronald Coase, however, asked the question that flummoxed believers in the above story line. If free markets lead to monopoly, then why isn't there just one gigantic firm that controls everything?

Coase and other theorized that the complexity and inertia that arise as organizational size increases impairs managerial decision-making. Rothbard added that economic calculation gets more difficult in concentrated markets because there is a lack of market prices available to effectively allocate resources.

Increasing organizational size, then, creates dis-economies of scale that work against the benefits of larger size.

Bylund fails to mention another factor that handicaps large-sized firms in competitive markets. Large firm inevitably become more vertically and horizontally integrated, i.e., more diversified. While some economies of scope are possible from diversification, productivity will generally be lower than that of smaller firms that specialize.

Sensing opportunities that larger, slower, less productive incumbents miss, smaller entrepreneurial specialists enter competitive markets and gain share as their superior productivity creates value in the marketplace.

Rather than facilitating large firm monopoly, then, unhampered markets constitute ecosystems of large and small firms cycling away in perpetual competitive struggle.

Which bids the obvious question: If large monopolistic firms are unlikely in free markets, then what situations actually facilitate monopoly?

Friday, July 5, 2019

Jobs Up, Rate Cut Hopes Down

You like to think that you're immune to the stuff, oh yeah
It's close to the truth to say you can't get enough
--Robert Palmer

A stronger than expected jobs report this am has quickly quelled expectations for a July rate cut from the Fed. The 10 yr is getting hammered, dividend paying stocks are selling off, and gold has dropped nearly 30 handles.

One of the few sectors trading dry is the banks, presumably because rising long bond yields steepen the yield curve for carry trade activities.

Hard not to speculate that market participants won't somehow rationalize that the Fed will still deliver a summer dose of stimulant to satisfy the market's rate cut addiction. Many gold-related instruments are off their lows, perhaps in sympathy to that prospect.

position in gold

Thursday, July 4, 2019

Declaration of Radicals

"A high treason. That's what these men were committing when they signed the Declaration.  Had we lost the war, they would have been hanged, beheaded, drawn and quartered, and--my personal favorite--had their entrails cut out and burned. So, here's to the men who did what was considered WRONG, in order to do what they knew was right...what they KNEW was right."
--Benjamin Franklin Gates (National Treasure)

Two hundred and forty three years ago today the Continental Congress ratified our first law. The underwriters knew that, should their declaration be put down, then they would be executed by the Crown for committing treason. They were the nation's first radicals.

Their declaration remains radical as well. That people are free by natural right, and that they are beholden to no government that tramples that right.

Today let us pray that one day the ideas of freedom and liberty will no longer seem so radical.

Wednesday, July 3, 2019


"Do you realize that the past, starting from yesterday, has actually been abolished? If it survives anywhere, it's in a few solid objects with no words attached to them, like that lump of glass there. Already we know almost literally nothing about the Revolution and the years before the Revolution. Every record has been destroyed or falsified, every book rewritten, every picture has been repainted, every statue and street building has been renamed, every date has been altered. And the process is continuing day by day and minute by minute. History has stopped. Nothing exists except an endless present in which the Party is always right."
--Winston Smith (Nineteen Eighty Four)

Over the past few years, statists have increasingly engaged in iconoclasm. Iconoclasm is the attacking, rejection, or destruction of established beliefs, values, and practices along with their associated artifacts and institutions. In ancient times, the motivation was primarily religion. Today, iconoclasm is done mainly for political purposes (for statists, of course, politics is religion).

The objective of the campaign is to destroy or disparage American history. Sever ties with the past and perhaps US citizens will acquiesce once more to a state of despotism.

This week we celebrate the birth of a nation founded on the principle of liberty--a principle that the iconoclasts detest. The best way to foil the iconoclasts is to remember our founding, and to securely pass those memories to the next generation.

Tuesday, July 2, 2019

Balance Sheets

Shine sweet freedom
Shine your light on me
You are the magic
You're right where I want to be
--Michael McDonald

In the last two missives we examined income statements and cash flow statements. The last of the financial statement trilogy is the balance sheet. We touched on the balance sheet a few posts ago when discussing net worth. A balance sheet reports what is owned (assets) and what is owed (liabilities). The difference between the two is called net worth, or in the case of investors, 'shareholder equity.'

The key information I like to glean from a balance sheet is how much cash a company has versus how much debt it has. Cash is freedom and flexibility while debt, as we have noted, reduces freedom and limits future options. Cash, short term investments, and other cash 'equivalents' are usually the first thing reported under the Asset section of the balance sheet. Once again returning to our Intel (INTC) example, the company's most recent annual balance sheet reports $3.0 billion in cash and cash equivalents and another $2.8 billion in short term investments (all of these are liquid, cash-like assets). Intel's total cash, then, is $3.0 billion + $2.8 = $5.8 billion.

We can also see that the company's total cash has been declining over the past four years (it had been $18 billion in 2015). That's a negative. We'd rather see it going up over time.

Now let's look at long term debt, usually reported near the end of the Liabilities section. For its most recent fiscal year, Intel reports $25.1 billion in long term debt. Long term debt has also been increasing over the past four years. That's undesirable; we'd rather see it going the other way.

We can compare cash to debt in a couple of ways. We can find 'net cash' by subtracting long term debt from total cash. For Intel, net cash = $5.8 billion - $25.1 billion or -$19.3 billion. We could also calculate the ratio of cash to long term debt: $5.8 billion/$25.1 billion = 0.23.

The strongest balance sheets are those where there is more cash than long term debt (positive net cash; cash:debt > 1.0). That way, a company can quickly use cash to extinguish debt and gain more flexibility.

Once upon a time, many companies operated with strong cash positions. Unfortunately, in the debt-laden world that we live in, that kind of balance sheet strength is largely a thing of the past. Most corporate balance sheets have weakened considerably. Not too long ago, Intel had gobs of cash and zero debt--a bastion of balance sheet strength. Personally, I've had to become more comfortable situations like Intel's and resolve to invest in companies with balance sheets that are 'less bad' than others.

That completes our synopsis of the financial statement trilogy. With a little practice you can navigate these statements like a pro for info that will make you a more knowledgeable investor.

position in INTC

Monday, July 1, 2019

New Highs

'Cause she's so high
High above me
She's so lovely
--Tal Bachman

Favorable news from the G20 summit over the weekend has propelled the SPX to all time highs this am. The reverse head-and-shoulders tracing over the past few weeks was a technical hint that a bullish move was brewing.

Now the bulls have hold onto their newly won territory. Giving it back here would quickly shift the mo-mo back to the bears.