Tuesday, December 19, 2017

Efficient Markets

      As a professor, I tend to be quite wedded to the idea of efficient markets that has played such a large role in academic research.  But every so often something comes along to remind that assets do get mispriced.  Below is one of the funniest examples.

U.S. regulators temporarily suspended trading in Crypto Co. over concerns that the stock is being manipulated after it surged more than 2,700 percent this month, making paper billionaires out of top executives. Crypto is the product of a reverse merger with a company that made water and radio-wave resistant sports bra pockets, according to a November filing. Last week it issued stock to accredited investors at $7, a 97 percent discount to the prior day’s closing price.

Sunday, December 17, 2017

The Tax Bill

       First some full disclosure.  I am a Republican free market economist.  I believe in the importance of individual incentives and responsibilities.  I believe in limited government where reasonable.  I think the tax code should be as simple and transparent as possible.  For over 10 years, I have advocated a revenue neutral rewriting and simplification of the tax code to encourage saving, investment, and entrepreneurship and to reward hard work.

       Changing the tax code is a huge undertaking.  In personal terms, you can think of it as building a complicated house.  It can only be done every few decades.  The Republican party had a chance to deliver something of great value to the country.  With careful planning and forethought it could build a "dream house."  What they did was throw up a hastily built shack.  It is as complicated as what it replaces.  It is not revenue neutral.  It tends to favor corporate interests.  It is not supported by a majority of the American populace.

       My advice?  Tear it up and start again.  America does not need a shack, it needs the dream house.  I also see the current bill as a great threat to Republican politicians.  As all the leaks in the roof become apparent, the drafters will get blamed.  And when the fiscal house finally falls down, Republicans will be sent packing.

Thursday, December 14, 2017

OK, Bitcoin

      Ok, I am breaking down to write something about Bitcoin.  It seems that everyone I talk to has a question about it.  The problem is that virtually everything I can think of about the subject has been said - usually many times.  In my view, the best summary is the one provided by John Cochrane in his blog (a link is on the left).  But there is one thing that has perhaps not received enough attention.

       Imagine you walk into an office supply store to buy a ball point pen.  You see two identical pens on the shelf.  One costs $5 and the other costs $50.  If you think that makes no sense you are applying the law of one price.  The law of one price says that identical goods sold in the same market must sell at the same price.

       There are currently about 160 cryptocurrencies and they trade at nothing like the same price.  Bitcoin, currently at about $16,000, trades at a price up to 100 times that of its major competitors.  How do they differ?  Not in terms of payout - none of the cryptocurrencies offer any dividend or interest.  Not really in terms of their use as a medium of exchange - Bitcoin may have a tiny advantage here but none of the cryptocurrencies viably competes with the dollar.  Not in terms of the way they are organized or exchanged - all of them use blockchain technology.  Why then the big price difference?  All I can think of is that Bitcoin is a better vehicle for speculation.  Because it is better known people think that other people will buy it at a higher future price.  In other words, Bitcoin is a better bubble vehicle.  Which suggests that Bitcoin's price is a bubble in the first place.

       One final thing.  Some people say that Bitcoin's current price, and higher future prices, are justified because the supply is limited.  The supply of what?  While it is true that there can be no more than 21 million Bitcoins, there is no limitation on cryptocurrencies.  Saying the supply is limited is like saying the supply of Pentel pens is limited.  Who cares is other suppliers are making identical pens.

        My bottom line on Bitcoin - stay away.

Tuesday, November 14, 2017

GE and Value Creation (Destruction)

      Perhaps the most common theme of this blog is that value creation comes from lean, well managed companies that have sufficient barriers to entry to be able to produce reliable and growing cash flow streams.  It is much less likely to come from financial transactions and restructurings.  The key is to focus on the details of running each specific business and let the stock market and the macro economy take care of themselves.

       GE seems like a company that should be doing well by these criteria.  It has a dominant market position in a variety of important businesses.  But it has fumbled across the board.  Costs, including overhead and management compensation, were allowed to expand without sufficient justification.  The Board grew to an unwieldly size.  Accounting became so complex that accountability and incentives were compromised.  As a result, in the current year the company managed to see its stock fall 40%.  Quite a miraculous for a large firm in a market that has risen 15%.

      This is a case where stockholders deserve to be angry.  Often collapses in stock prices occur because of factors that management could not anticipate or control like the financial crisis or the drop in oil prices.  But in the case of GE, it is hard to find such explanations.  Management deserves most of the blame.

      In my view, the path forward is not more restructuring, but cost cutting and attention to the details of the individual businesses.  The division that makes locomotives, for example, does not to be sold.  Railroads are four times as efficient as trucks on a ton per mile basis.  As energy costs grow and environmental issues become more pressing, we will need more rail and that means more locomotives.  That is a business that GE should make work.  There are many others.

Monday, November 13, 2017

Education and Social Media

      Becoming educated is not easy or natural for most people.  Were it like learning to walk, we would not need this immense social infrastructure of schools, teachers, administrators, assignments, exams, grading and so forth.  Educating young people requires a lot of pushing, cajoling and enforced discipline.  And it takes a lot of time.

      On the other hand, there are things that are naturally of interest to young people like, cool, gossip, physical appearance, social status and the like.  Those things command their attention without the need for all the outside influence and support real education requires. 

       The economic goal of social media is grab attention and to sell it.  The way to grab attention is to guess what people naturally want to look at and then let sophisticated software continuallly refine the offering in order to keep a person's attention.  You can get a pretty good idea of how this process comes out by looking at the cell phone of a 14-year old (if you can ever get hold of one.)

       From a social standpoint, the process of giving the young what most grabs their attention is a bit like selling drinks to alcohloics.  And great algorithms can be very expert in mixing the most enticing drinks - drinks that can easily crowd out the drugery of learning algebra.

       What does this have to do with a blog on investing?  A lot.  Education is the investment that society makes in its people.  The payoff is a more civil society and a stronger economy.  Social media is reducing the return on that investment but the social media firms do not bear the cost. 

Tuesday, November 7, 2017

Another Indicia of Excess

      Low real interest rates encourage investors to leverage their investments.  As long as prices are rising or stable, this leverage results in higher returns.  But if prices start to drop, it can lead to fire sales and insolvency.  Therefore, you would hope that as asset prices rise investors might conclude that the risk of a collapse was rising as well and cut back on leverage.  No such luck.  As the chart shows, the run-up in stock prices has been accompanied by a marked increase in leverage.  If there is a sudden drop in prices, it could quickly turn into a route.

Monday, November 6, 2017

Bitcoin and the Fed

      At the outset let's be clear on the relation between Bitcoin and blockchain technology.  Blockchain technology is one of the most important economic innovations in decades.  It has the potential to revolutionize transacting and record keeping.  Its developers, if we ever find out who they are, should be at the top of the list for the Nobel Prize in economics.

      Bitcoin applies the block chain technology to a crytocurrency.  For more details on the economics of Bitcoin, I recommend the blog of my colleague Aswath Damodaran.

       The massive price increase in Bitcoin has generated a great deal of attention and controversy.  In my view, Bitcoin is the most sophisticated chain letter in history.  As Prof. Damodaran notes, Bitcoin is not an asset because it provides no cash flow and is not a commodity because it provides no useful service.  It is at best a poor substitute for national currencies.  But despite these deficiencies, it is an ideal vehicle for the development of a speculative bubble because the risk of transacting has been removed.  I am definitely in the camp that Bitcoin is a modern day tulip and is headed to a collapse similar the that which occurred in Holland in the 16th century.

      How does the Fed fit in?  In my view, the nearly decade long experiment in negative real short-term interest rates and quantitative easing has led to an almost pathological search for investment return.  And nowhere is that pathology more clear than in Bitcoin.  I cannot get a haircut these days without my barber asking me about Bitcoin.  He says he bought at $3,000 and has more than doubled his money.  I hope he sells soon or he may have to cut a lot of hair.

Thursday, November 2, 2017

Tesla Below 300 GE under 20

      It has been a long time coming but Tesla is finally starting to be valued like and automobile company - which it is.  That means it has to compete with numerous experienced companies in a highly capital intensive industry.  It also has to deal with the same labor relations that other car companies do.  At $300 the valuation still looks high relative to my DCF models, but it is leaving the ludicrous zone.

       GE, on the other hand, is the only major company that I have modeled that is undervalued.  In today's bubbly market, everything I look at seems very expensive.  GE under $20 is starting to look like a bargain.  Maybe not a big enough bargain to pull the trigger, but definitely a big enough bargain to follow closely.

Friday, October 27, 2017

Amazon and GE earnings

    For the third quarter of 2017 GE net income after tax was 1,836 million.  The quarter was universally assailed as a disaster for the company and the stock dropped sharply.  Amazon's net income for the third quarter as 197 million.  On the announcement of that number the stock jumped more than 130 dollars.  If you ever needed evidence on the importance of expectations and the fact that investors take account of the long-term you need look no further.