"Margin of Safety" Summary

A good summary of Seth Klarman's (now out of print) Margin of Safety is now available through the Motley Fool.

Close to the Top in Mining?

From today's Journal:

"Now, after several years of hefty profits, shareholders are pressuring mining companies to show they have projects in the pipeline to sustain growth over the next decade.

At the same time, banks and other providers of capital are becoming more comfortable financing mining ventures, including higher-risk projects developed by lesser-known "junior" companies. These include outfits like Nautilus Minerals Inc., a Vancouver, British Columbia, company that said it has raised $300 million for a project to mine gold and copper from the ocean floor near Papua New Guinea, with backing from several major mining houses.

"It almost seems at the moment, if you have a piece of paper that has an outline for a project, you can" get money, said Mark Tyler, head of mining and resources at Nedbank Group Ltd., a South African bank.

Chrysler's Rounding Error

According to Merill Lynch Chrysler's liabilities for pension and retiree health care is $52.5 billion.

The company's equity is estimated to be worth $6.5-9, if it were split off of DCX. Add on the traditional debt and you have some serious leverage.

Inflation is Dead (Except for Food)

Last week Chairman Bernanke testified that inflation generally appears contained, but that the Fed. remains vigilant.

This is good news, especially if you noticed Hormel's quarterly earnings call, Hormel expects higher grain costs:

"will continue to burden our turkey operation, and we are working hard to find ways to offset this extra expense, including through advances in pricing," said CEO Jeff Ettinger.

Corn costs driving up turkey costs, sounds a lot like the seed of inflation to me.

Oil at $30?

From Bloomberg:

"Oil will drop more than 30 percent to $40 a barrel in March and may drop to $30 as rising prices for storing crude lead to a `breaking point' that forces speculators to sell, Sanford C. Bernstein & Co. said.

""As storage fills up, storage costs rise and the contango widens,'' the analysts said in a February report. ``At some point, investors will reallocate money away from the commodity funds, causing futures prices to fall.''

"The ``breaking point'' could come in March if Saudi Arabia, OPEC's largest producer, fails to cut production below 8 million barrels per day, the level needed to keep the market balanced, the Bernstein analysts said. Spare capacity would rise, widening the contango and driving investors out. "

Even Good Managers Have Bad Years

With the end of Bill Miller's highly publicized streak of beating the S&P 500 coming to an end at the end of 2006 (as well as a bad year for Bill Gross and about 80% of active managers), this is a good time to think about when investors should consider selling a mutual fund.

Litman / Gregory recently did a study of mutual fund manager under performance during long term periods of superior performance, a study referenced in Nick Murray's most recent column in Financial Advisor. Their results are compelling if not totally surprising. Litman finds that at least 93% of large cap managers who beat the index by 1% or more over a 10 year period will out under perform the index by 2% or more over a three year period during their 10 year run of superior performance. Furthermore, 64% will have a three year period where they trail 5% on an average annualized basis, very bad numbers to say the least.

Let me make those figures easier to read: even the best managers will do poorly over significant periods of time on their way to great performance records.

The lesson is simple; investing is like all human endeavors and results can be lumpy and irregular more often than they are neat and consistent. According to the study's authors the three year periods of under performance are often created by one bad year that is not immediately corrected by great performance in the following year.

This study rebuts the idea that investors need to (or pay someone to) closely "watch" their funds for index under performance and sell funds that lag over short time periods. This is a common marketing point for advisors who believe that they can earn better performance by selling funds after short periods of under performance.

The reality is that, like most things in life, good manager selection probably has more to do with understanding the people and philosophy of a firm than on what they have produced in the last day, month, or quarter. If investors spent more time getting to know the people who manage their money they would probably own fewer funds and have less anxiety when they trail some random benchmark, longer holding periods would be the result which would mean less in taxes and better overall performance.

What Qualifies as a "Win"

The FT erroneously reported yesterday that Blackstone had won the bidding for Equity Office Properties, a large REIT.

In reality Vornado won the bidding by dropping out, now Blackstone will have to pay the $39 billion it bid for EOP. Equity Office owns office buildings and profits from people renting those offices. Currently EOP has just over $26 billion of real estate on its books, less depreciation $22 billion. While these buildings could be on the books for substantially less than what they are really worth, the deal prices them as if they were worth 50% more than their book value.

The company trades at a 66 P/e ratio and at a dividend yield of only 2.38%, that means that at the price of $39 billion, these properties are going to provide less income than Blackstone could have earned by investing in Treasuries. That means that in a tough real estate market with rising interest rates, Blackstone has a huge bet on the price appreciation of these buildings, quite a win indeed.

Defense Spending Strong, Will Remain Strong

According to General David Baker (Ret.)

“The Chief of Staff of the United States Army, General Schoomaker, has said that his biggest costs don’t start until the last bullet is fired in Iraq. That drops a few jaws when I get into conversations with people about this subject, but resetting the forces and giving the Marines back all the equipment they loaned the Army is indeed very expensive, and that’s going to continue”

General Dynamics is the Army’s top supplier for armored vehicles and should benefit from increased equipment spending. While GD certainly isn't the cheapest stock in the defense sector, it is uniquely positioned from the needs of the US military

E-T-F'd

This weekend's Journal reports on the rational and well thought out way individual investors are using Exchange traded Funds (ETFs) to add a lot of juice to their portfolio. Now I love ETFs, they are a great way to get easy, transparent access to defined market segments, unfortunately they also allow poorly informed speculators to make silly bets on parts of the market they know little about.

Media consultant Steve Sox shares that since his mutual funds weren't "doing anything" he built a portfolio of EFTs all by himself now he "easily" outperforms market indexes. Since most ETFs track a market index, I have a feeling Steve may be taking on a little more risk than the indexes he is so easily outperforming.

Retired consultant Stan Zawrontny shares that he has committed nearly one third of his assets to a set of ETFs that focus on emerging market countries like Brazil. He tells us that "I didn't like the returns that mutual funds were getting." so he chose to carefully and rationally evaluate the geopolitical environment, inflation and economic growth scenarios and buy an ETF that tracks the market in Singapore.

While I think it is amazing that people like these guys who appear to have no related education or experience can make such complex decisions, it is good to see that the individual investor has once again found a way to beat out all of those stupid fund managers who you know, study investments all day.

In an unrelated note, Barron's also reports that margin debt hit an all time high last week, passing its previous high set in March 2000.

Looking at history and common sense, I recommend investors rush into the market immediately, preferably by buying into a sector of the stock market that they know little about but that seems like it will yield high returns.

Spend, Spend, Spend

From Seeking Alpha:

"The Commerce Department reported yesterday that Americans had a 2006 savings rate of -1% -- not only did they on average spend everything they earned, but also dipped into their savings or borrowed money to finance their spending.

2005 savings were -0.4%; this year's figure is the worst since the -1.5% figure of 1933, in the midst of the Great Depression. The rate has now been in negative territory for 21 straight months; 2005-06 is the only the second time it's ever been negative, the other being 1932-33.

Economists have various theories to explain the current lack of savings, from over-reliance on a strong economy/home equity to a consumerist mentality that drives people to spend even when they can't afford. In other figures released yesterday, consumer spending rose 0.7% and incomes rose 0.5%, both in line with forecasts. The Institute for Supply Management said its benchmark index came in at 49.3 last month, down from December's 51.4; anything below 50 is considered contracting. From the Department of Labor, initial unemployment claims were down 20k to 307,000, pushing them to their lowest level in a year.

Not So Fast on the Housing Recovery

According to Merrill Lynch:

"Housing market affordability is not only still more than 20% below the norm, but is actually deteriorating again: the NAR's affordability index receded to 109.2 in December from 110.7 in November, ending a string of four monthly improvements in a row. This, even with continued income growth and lower home prices -- the culprit was the backup in mortgage rates."