Good Reading -- August 2011
Facts and Figures
The first half of 2011 (ended June 30) was an eventful, costly and tragic one for those affected by natural disasters. Due largely to the Japanese earthquake and tsunami in March, the ~$265b in economic losses is already well ahead of the previous worst-ever year of 2005 (which totaled $220b for the entire year, largely due to Katrina)...and historically, 2nd half losses greatly exceed those of the 1st half.
the preliminary total for economic damage from the Japanese earthquake and tsunami ($210b) makes it the costliest disaster on record (Katrina was only $120b)
Insured losses ytd 2011 are running ~$60b, five times greater than the average year since 2001.
But while severity is up, the total number of insured events (355) is actually somewhat below the trailing 10 year average (390). (Source: Munich Re)
The S&P 500, on a unit value basis, is estimated (by S&P itself) to earn $96 this year. At 1200 (and falling?), that's 12.5x -- sounds awfully reasonable, right? But on the same unit value basis, the book value of the S&P 500 is $360 -- that's a multiple of 3.33x and an ROE of more than 26%...and those numbers are not so reasonable. (Berkshire has earned 20% over the long haul; other examples with a 2 as the first digit are scarce, to say the least. Berkshire also currently trades at <1.2x, which implies a pretty bleak earnings future for the company, despite its track record and despite its ownership of a multitude of great businesses that could be considered bellwethers for the broader economy.) The S&P 500 did post an ROE of 21% in 2010, but the obvious implication here is not a positive one for both future returns on equity and the (eventually) corresponding market level. (h/t Horizon Asset Management)
In a follow up to last month's link to an article by Joel Greenblatt, I'd like to draw your attention to a profile of Greenblatt and his new fund in Santangel's Review. The website and newsletter are devoted to finding "undiscovered investors," with a strong value-investing bent. It's truly an excellent publication, and the March profile of Greenblatt and Gotham Asset Management is one of the best investor profiles I've ever read. Greenblatt doesn't get the feature-length articles or biographies so common to Buffett and others, but he should. I can't recommend this profile enough, and Steve Friedman, the main man behind Santangel's Review, is offering an excerpted version for Accredited Investors -- email him at email@example.com.
"A Conversation with Gary Klein" -- an applied psychologist, Klein has a lot of good insights. Endorsed by none other than Daniel Kahneman.
"Corporate America Will Miss Munger-as-Mencken" -- a farewell/paean to Charlie Munger by Buffett biographer Alice Schroeder. Even better, here are some excellent notes from Charlie Munger's last annual meeting, courtesy of Ben Claremon's excellent blog.
"Inside RIM: An Exclusive Look at the Rise and Fall of the Company that Made Smartphones Smart" --interesting comments from insiders, highlighting just a fast a dominant company like this can fall.
"Honest Tea Declares Chicago Most Honest City, New York Least Honest" -- there were only 5,000 samples in this "study, but I'm still shocked that the numbers were so high across the board. Maybe we're not doomed after all...but then again, if Chicago's so honest, where do all those crooked Chicago politicians get it from?
Byliner Spotlight: The Pulitzer Winners -- a collection of Pulitzer-winning articles from 1994 onward.
"Inside Pfizer's Palace Coup" -- very interesting look at Pfizer's leadership and culture over the past decade. Highly recommended.
"Government Housing Policy: The Sine Qua Non of the Financial Crisis" -- the latest good stuff on the housing market from Ed Pinto.
"Dan Ariely on Behavioural Economics" -- courtesy of The Browser. I highly recommend this article and the books referenced in it.
"What Does Bill Gates Read for Fun?" -- these great recommendations are apparently from the man himself. Categories include education, energy, development, health, and economics, among others.
Jim Grant: "I think I have proven -- not once, but over the course of years -- that I have no idea when bond yields are going to be going higher. My only observation is that they yielding scarcely more in most cases, and in many cases less, than the existing rate of inflation. And Benjamin Graham told us all that we ought to insist on a margin of safety in our investments." (Source: Bloomberg)
More Grant: "Kids today talk about beer goggles -- an especially sympathetic state of perception with regard to a member of the opposite sex. We collectively wear interest-rate goggles because we see market values through the prism of zero-percent funding costs. Everything is distorted."
Everything you need to know about sell-side analysts captured in two sentences: "[Berkshire Hathaway] equity is the cheapest I've seen it in a long, lone while. It's hard for me to get really positive on that." -- Tom Lewandowski, analyst with Edward Jones, who rates Berkshire a "hold." No analysts, as surveyed by Bloomberg, rate it a "buy."
Stanley Black & Decker (SWK), in its most recent proxy, made the bold and admirable declaration that it “does not believe it is necessary for the attraction or retention of executive talent to provide our executives with a substantialamount of compensation in the form of perquisites. The Company does, however, provide its executive officers with some perquisites, including financial planning services, life and long-term disability insurance, car allowance, home security system services, executive medical exams, and up to $5,000 of company products...” So how does SWK define "substantial" and "some"? Here's a list of benefits for Executive Chairman Nolan D. Archibald:
$526,391 of personal plane travel
$39,671 in reimbursed financial-planning costs
$9,522 for personal use of a company car
$16,200 as a car allowance
$4,528 in “personal use of tickets to athletic and other entertainment events”
$1,820 in club dues
$2,635 in free tools or other company merchandise
And none of that includes a $1.2 million base salary (in cash) or a huge helping of options, which takes his total compensation to $28.2 million. But he still needs $2,635 worth of tape measures and screwdrivers? I'm shocked that only 54 percent of shareholders voted against the executive compensation packages and that 35 percent gave them a thumbs up. (Source: Footnoted.com and company filings)
"Resource Limitations 2" -- since the first installment was so, um, popular, here's the second installment of Jeremy Grantham's rant. The same caveats/concern apply.
"SEC works to get rid of the 'lease to nowhere'" -- this is a special brand of incompetence even by SEC standards. (Source: footnoted)
"Short-termism and the risk of another financial crisis" -- this is a good editorial by Sheila Bair, the recently departed chair of the FDIC. She had the (mis)fortune of serving in that role for five years beginning in 2011. Overall, she did a pretty good job. Joe Nocera recently published this profile, which captures most of her thinking. (I do have to note that it shamelessly omits the absolute debacle of Washington Mutual, in which she and the FDIC really screwed bank-level bondholders in favor of JP Morgan and otherwise acted in direct opposition to the law, precedent, logic, and how she elsewhere professes to behave -- see here for the tip-of-the-iceberg post-mortem from a neutral third-party in the Examiner's Report (skip to the five-page summary, Part III, particularly Section B). Anyway, short-termism is indeed a major problem in finance/business and politics, and most of this editorial is based on good, rational thinking.
"The Economic Manifesto of Elliott's Paul Singer" -- Wow. I read a lot of investor letters, and this is probably the most vivid, direct, inflamed writing I've ever seen. Unfortunately I couldn't find a copy of the full original, but you'll get the idea from this article.
Excerpt from Emerson Electric's second quarter earnings call -- wouldn't it be great if all CEOs talked this way on earnings calls?
SEC works to get rid of “The Lease to Nowhere”…
by Sonya Hubbard
The temperature may have officially reached the high 80s yesterday afternoon in Washington, D.C., but we bet it was significantly hotter in room 2167 of the Rayburn House Office Building.
That’s where the SEC’s Chairman, Mary Schapiro, and its Inspector General, H. David Kotz, were in the hot seat to answer questions for the Congressional Sub-Committee on Economic Development, Public Buildings, and Emergency Management (which falls under the auspices of the Committee on Transportation and Infrastructure) about the $556 million, 10-year lease that the SEC signed last summer for 900,000 square feet of space in D.C.’s Constitution Center. (A video of the hearing is available here.)
The tone of the hearing was clear from the title of the Briefing Memo: ”Oversight Hearing on ‘The Securities and Exchange Commission’s Fleecing of America: Part Two.’” But while the title strikes us as political hyperbole (do people really suppose that SEC employees really intended to “fleece” Americans?), the facts related to the lease itself are a black eye on the agency charged with protecting investors. Moreover, given the current budget deficit woes and focus on government waste, it’s easy to understand why this was red meat for both Democrats and Republicans.
Opening the hearing, Chairman Rep. Jeff Denham (R – Calif.) took Schapiro to task for verbally approving the massive lease “based on a 10-minute, unscheduled meeting.” He continued, “It is inconceivable that the SEC bound the taxpayers to more than a half billion dollars based on back-of-the-envelope calculations that were inflated and just simply wrong.”
Last summer, the passage of the Dodd-Frank Act led the SEC to predict that it would need to hire as many as 800 new staffers to handle all the extra work that the legislation would mandate. But when Congress finally hammered out its appropriations, it didn’t give the SEC the money it needed for a big staff expansion. And in between those two points in time, the SEC signed the Constitution Center lease.
The evidence suggests that Schapiro herself didn’t personally push for the space at Constitution Center (according to both a witness and Schapiro’s written testimony). But she did set certain parameters including that the new space be within walking distance of the SEC’s existing headquarters near Union Station, which is primo real estate in D.C.
Yesterday, Schapiro said she got some really bad advice and recommendations from employees in positions of authority, who gave her an “urgent recommendation” that led her to believe that the Constitution Center space was the only suitable space that was still available, and that the SEC was at risk of losing the space because competing parties were poised to swoop in and lease it first.
Inspector General Kotz’s written testimony, rooted in conclusions formed after his staff read more than 1.5 million emails (and we thought that we read a lot of stuff) and interviewed 29 people, puts the blame primarily on the SEC’s Office of Administrative Services (OAS), which
“…conducted a deeply flawed and unsound analysis to justify the need for the SEC to lease 900,000 square feet of space at the Constitution Center facility. Specifically, we found that OAS grossly overestimated (by more than 300 percent) the amount of space needed for the SEC’s projected expansion and used these groundless and unsupportable figures to justify the SEC’s commitment to an expenditure of approximately $557 million over 10 years.”
And that’s not all the SEC did wrong. Other flaws included negotiating a ”single source” contract over the course of just a few days, back-dating an important document (the “Justification and Approval” form), and signing that form after the lease had already been signed.
Unlike other notable examples of bureaucratic waste, heads may (metaphorically) roll over this one. Kotz testified that steps are underway to discipline “two senior individuals” and possibly a third individual, and that may include firing them. The matter has also been referred to the Department of Justice, which will determine whether criminal charges are appropriate.
Nothing lets Schapiro off the hook, nor is she trying to escape blame. After testifying that she was “extremely disappointed” by the flaws in the SEC’s leasing processes, she added:
“As Chairman of the SEC, I am ultimately responsible for the actions of the agency. I can assure you that the SEC will address the issues identified by the IG aggressively and transparently. As I have said previously, the true test of an organization is not whether things go wrong, but how the organization responds to problems and whether its leaders take such opportunities to make necessary improvements.”
So far, two-thirds of the Constitution Center space has been leased to other tenants, and the General Services Administration (GSA) has identified “prospective tenants with leasing needs that may align with the available Constitution Center space.” Schapiro has also asked the GSA to assume future leasing responsibility for the SEC, which makes sense, since it handles that task for other agencies.
Even if tenants are found for the entire space, the whole incident raises serious questions about an agency charged with monitoring these sorts of things for publicly traded companies. Anything that makes the SEC look weak and impotent (or, perhaps weaker and more impotent) is bad for investors and needs to be resolved quickly.
Short-termism and the risk of another financial crisis
By Sheila C. Bair, Published: July 8
The nation is still struggling with the effects of the most serious financial crisis and economic downturn since the Great Depression. But Wall Street seems all too ready to return to the same untenable business practices that brought it to its knees less than three years ago.And some in government who claim to be representing Main Street seem all too ready to help.
Already we have heard rationalization of the subprime mortgage debacle and denigration of those of us who have advocated long-term, structural changes in the way we regulate the financial industry. Too many industry leaders, as well as some government officials, compare the crisis to a 100-year flood. “Who, us?” they say. “We didn’t do anything wrong. Nobody saw this coming.”
The truth is, some of us did see this coming. We tried to stop the excessive risk-taking that was fueling the housing bubble and turning our financial markets into gambling parlors. But we were impeded by the culture of short-termism that dominates our society. Our financial markets remain too focused on quick profits, and our political process is driven by a two-year election cycle and its relentless demands for fundraising.
I’ve had a unique vantage point during my five-year term as chairman of the Federal Deposit Insurance Corp., from the early failure of IndyMac Bankto the implementation of reforms designed to ensure that no conglomerate ever again is deemed “too big to fail.”
Now that I’m stepping down, I want to sound the alarm again. The common thread running through all the causes of our economic tumult is a pervasive and persistent insistence on favoring the short term over the long term, impulse over patience. We overvalue the quick return on investment and unduly discount the long-term consequences of that decision-making.
Our decades-long infatuation with financing our spending through ever-growing debt, in the private and public sector alike, is the ultimate manifestation of short-term thinking. And that thinking, particularly in business and in government, is actually getting worse, not better, as we look for solutions to put our economy on a sounder footing.
Today, some want to repeal or water down key financial reforms, fearing that strengthening the rules for firms will curtail our recovery. But the history of crises makes clear that reforms will make our economy stronger in the long run.
While short-termism on Wall Street and in Washington was a huge driver of the most recent financial crisis, we all fall prey to this tendency to some extent.
Households have failed to save enough money to carry them through hard times or to achieve long-term goals. It became old-fashioned to save up for the down payment on that first home. Taking out a mortgage shifted from the most serious financial decision a family would make to a speculative bet on how far home prices would rise. Homeownership went from being a source of stability in our economy to a source of instability.
Business executives squeeze expenses of all types to meet their quarterly earnings targets, even cutting research and development that could create a competitive advantage down the road. This market failure leads to under-investment in projects with long payoff periods. “Patient capital” has become almost quaint.
And policymakers do everything they can to avoid acknowledging a problem or policy mistake, even as it grows more difficult and expensive to fix with each passing day.
In our routine decision-making, research shows, we increasingly use the part of our brain attuned to greed, fear and instant gratification. This short-termism is reinforced when economic incentives are taken into account.
Performance-based compensation, for example, can have disastrous results when it fails to consider long-term consequences. This is particularly true in financial services, where the downsides of risk-taking may take years to materialize but can lead to failed banks, foreclosed homes, unemployed workers and a credit shortage for small businesses. This past week, the FDIC adopted a rule that allows the agency to claw back two years’ worth of compensation from senior executives and managers responsible for the collapse of a systemic, non-bank financial firm.
To date, the FDIC has authorized suits against 248 directors and officers of failed banks for shirking their fiduciary duties, seeking at least $6.8 billion in damages. The rationales the executives come up with to try to escape accountability for their actions never cease to amaze me. They blame the failure of their institutions on market forces, on “dead-beat borrowers,” on regulators, on space aliens. They will reach for any excuse to avoid responsibility.
Mortgage brokers and the issuers of mortgage-based securities were typically paid based on volume, and they responded to these incentives by making millions of risky loans, then moving on to new jobs long before defaults and foreclosures reached record levels.
Such arrangements gave rise to the acronym IBG-YBG(“I’ll be gone, you’ll be gone”), a watchword for short-termism in the mortgage industry during the boom.
When the housing bubble burst, home values started to fall and adjustable-rate loan payments ratcheted upward, and subprime borrowers began to default in record numbers. But the inherent short-termism of bankers and policymakers kept them from moving quickly to limit the damage as the financial crisis escalated in 2007 and 2008.
I was among the few at that time advocating for widespread loan modifications as an alternative to foreclosure, which was leading to more displaced families, larger declines in home prices and more devastating losses for investors. But mortgage servicers, also typically paid according to volume, had neither the financial incentive nor the willingness to devote resources to a change in strategy. Their under-investment in servicing has led to a huge inventory of foreclosed properties and mounting litigation that is likely to cost them far more than any savings they achieved by cutting corners.
Government efforts to promote modifications, meanwhile, have gradually moved in the right direction but have remained behind the curve. At the height of the crisis in the fall of 2008, when fear over where the bottom was ruled the markets, policymakers were supremely focused on the short-term priority of preventing the failure of the nation’s largest financial companies. Government assistance to financial institutions took a variety of forms, amounting to a total commitment of almost $14 trillion by the spring of 2009.
While those actions were necessary to prevent an even bigger economic catastrophe, we still have not addressed the No. 1 cause of both the crisis and the subpar recovery we are in: a stubborn refusal to deal head-on with past-due and underwater mortgages.
It’s time for banks and investors to write off uncollectible home equity loans and negotiate new terms with distressed mortgage borrowers that reflect today’s lower property values. It is true that this would force them to recognize billions in mortgage losses — losses they mostly stand to incur anyway over time. But it will eventually be necessary if we are to clear the backlog and end the cycle of defaults, foreclosures and falling home prices that continues to hold back the economic recovery on Main Street.
The media has also played a role in expanding our short-termism. The type of information that dominates cable news and the blogosphere is generally not designed to appeal to our more rational, long-term thought processes. Instead, it excites our emotions, inducing greed and fear, and more often stokes prejudice and cynicism than rationality and fortitude. The 24-hour news cycle bombards us with constant information that compels action, not patience. Sound logic is often trumped by the sound bite.
On financial reform, “bailouts as far as the eye can see” is how some have described our efforts. In fact, the whole point of the new law is to prevent bailouts, which now are expressly prohibited.
Responsible policies are promptly vilified if they involve the slightest hint of short-term sacrifice. For instance, common-sense efforts to raise large bank capital requirements and to require issuers of mortgage securitizations to bear some portion of the loss when securitized loans go bad are resisted by the industry, which claims that such measures will raise the cost of credit and could derail the economic expansion.
But credible research shows that these requirements will lead to only a modest increase in the cost of credit, accompanied by a large improvement in economic performance over the long run because of a lower frequency and severity of financial crises.
There are many other examples of short-termism beyond the financial sector. Too often, the response to subpar economic growth has been another tax credit or a cut in interest rates that feels good for a while but does nothing to enhance the long-term performance of our economy. Far-sighted investments in job training and modernizing our physical infrastructure would surely pay greater dividends over time.
And as currently structured, our Social Security and Medicare programs will prove financially unsustainable as the baby boomers retire and both longevity and medical costs continue to rise. The rational thinker in each of us can appreciate the logic that reform is absolutely necessary to keep these essential programs viable.Yet the political debate cannot move beyond whatever combination of short-term sacrifices are being proposed to balance the accounts.
The current impasse in addressing the unsustainable growth in the federal debt also goes beyond mere partisanship to a distorted sense of the long-term national interest. One could hardly envision a market development more injurious to our economic security than a technical default on U.S. government obligations, which would lower our national credit rating from AAA status. At the same time, raising the debt limit without progress toward reducing our structural deficit would be equally irresponsible and unsettling to the markets.
Yet those are exactly the scenarios looming in the budget debate.
An electorate and a news media properly focused on the long-term implications of our government policies would rightly condemn any political position that even contemplated such outcomes. They would also press for more far-reaching reforms.
Our loophole-ridden tax system — which favors spending over saving, debt financing over equity, and homebuilding over other long-term investments — is badly in need of an overhaul as well. Closing loopholes would result in a more efficient allocation of capital and would allow us to reduce marginal tax rates while raising more revenue to help pay down our national debt. But most of us would have to give up some of our deductions and tax credits in the short term.
There are signs that suggest the public is already moving toward embracing thrift, at least in terms of personal finances. Total household debt is down by as much as 10 percent from pre-crisis levels, while the personal savings rate has risen to its highest level in more than 15 years.
It’s true that consumers who save more and borrow less won’t contribute as much to economic growth in the short run. But surely we have learned by now that there are limits to what excessive spending and borrowing can do for long-term economic growth and stability.
Our financial system is still fragile and vulnerable to the same type of destructive behavior that led to the Great Recession. Unless all of us — households, financial leaders and politicians — are willing to make some short-term sacrifices for longer-term stability, we are at risk of another financial crisis that will be just as bad, if not worse, than the last one.
Sheila C. Bair was chairman of the FDIC from June 23, 2006, through July 8, 2011. During her tenure, she oversaw the takeover of more than 300 failed banks.
The Economic Manifesto of Elliott’s Paul Singer
By EVELYN M. RUSLI and AZAM AHMED
“Stability is not the way of the world.”
That is how Paul Singer, founder of the $17 billion hedge fund Elliott Management, describes the current environment in his latest letter to investors, a 14,000-word screed that attacks government officials in the United States and Europe for their fiscal recklessness and portends an end to American hegemony should the ship not soon be righted.
In the colorful and often angry letter, Mr. Singer takes particular aim at the Federal Reserve (a “group of inbred academics,” in his view) for its use of artificially low interest rates and quantitative easing to stimulate the economy. The approach, he said, has distorted the price of just about everything.
“The distortions in public policy in the U.S. and Europe have introduced extraordinary undercurrents which are hidden from sight, but they are entirely capable of changing the landscape very quickly, and probably not for the better,” he said in the letter, which was obtained by DealBook.
Mr. Singer, whose fund gained 1.1 percent in the second quarter, released the letter several weeks before Capitol Hill reached a compromise on the contentious debt ceiling issue. That battle does not fully account for the country’s long term insolvency issues, he wrote, nor what he calls the “unpayable Big Three” — Social Security, Medicare and Medicaid.
“In both the U.S. and Europe, the budget and balance sheet numbers do not work,” the letter said. “When ‘off-balance sheet’ promises are taken into account, the U.S. and most countries of the Euro zone are insolvent.” And by extending reams of credit, the developed nations, he explained, are undermining their credibility, an erosion that — once complete — will exact untold consequences.
“As this is written, the prices of financial assets do not seem to take into account the risk of a history-altering reversal of confidence in paper money, the U.S. dollar, the American economy and its political leadership, or the Euro currency block.”
“Yet poor policy and incompetent leaders are creating massive systemic risks, and modern markets can concentrate and change their focus instantly — for all the right reasons, for no apparent reason, or for some combination of the two.”
Given the Fed’s “increasingly cavalier attitude” toward monetary policy, Mr. Singer said, it is up to the markets to “take away its freedom of action.” In that event, Elliott expects a “collapse” in the dollar’s exchange rate, a busted bond market and surging commodity prices — all accompanied by extreme volatility in the equity markets.
And as for how to extract the economy from the depths of whatever reckoning is to come, history does not inspire confidence in the eyes of Mr. Singer. Calling the government’s management of the financial crisis “horrendous,” Mr. Singer said the stimulus plan was a failure that led to a uniquely feeble recovery and an employment situation that “is simply putrid.”
“Instead of addressing the unsound financial system by deleveraging the banks, making them understandable and transparent, and modernizing the regulatory scheme, the bulk of the actions taken by the new government, starting in early 2009, consisted of an ideological wish-list and cronyism. Very little was oriented toward supporting the private sector, except for the surviving banks, which were nursed back to ‘health’ (that is, mostly as highly-leveraged trading shops) with lavish dollops of close-to-free money and blanket guarantees.”
So what would it take to fix the current dilemmas outlined by Mr. Singer, a hardcore conservative?
“Some are consumed with guilt and cry plaintively, ‘Tax me more, it feels so good!’ But many others will take their jobs, projects and ideas elsewhere, to places where they are not just thought of as sheep to be fleeced. The world, in terms of choices available to educated, ambitious workers and entrepreneurs, is way bigger than just the United States, Japan and Europe.”
Instead of raising taxes in a futile attempt to pay for burdensome entitlement programs, Mr. Singer said legislators should be focused on slashing obligations. He admitted that restructuring the health care system would require complex solutions, but Mr. Singer said there were also some easy fixes to trim costs, like lifting the retirement age or changing the way benefits are calculated.
And what to do about the Federal Reserve and its chairman, Ben S. Bernanke, whose confidence in the Fed’s ability to control inflation seems “more like careless talk radio rants than expressions containing the prudence and conservatism needed from the guardian of the value” of the dollar? Mr. Singer wants the Fed to ease off the gas pedal and change directions.
“The Fed should state that it has done more than enough, and that fiscal and regulatory policy needs to pick up the responsibility for growth and job creation.”
“We should demand that the Fed start commenting — in their beautiful prose — on the value of the dollar. They also need to start normalizing interest rates carefully, while developing intelligent policies to deal with the possible resultant decline in many asset prices (possibly balanced by optimism in the increased probability of sound money policies in the future). Until interest rates are normalized, capital will continue to be misallocated throughout the economy, real investment ‘risk’ will be almost impossible to determine and a firm foundation for solid growth in the American economy cannot be created.”
His most bitter medicine is perhaps reserved for Europe, which he chides for propping up Greece — “a hopelessly insolvent country.” Mr. Singer’s solution is simple: let Greece fail. He argues that Germany and France can only write so many checks before “elected officials are dragged out of the Reichstag by voters, or until German credit is on the verge of collapse.” Although the countries have become the informal lenders of last resort for the continent, Mr. Singer warns that they too are on shaky ground.
“The appropriate course is for Greece (and perhaps others) to have as controlled a default as possible and to exit from the Euro. The ’strong’ European countries will then have to ameliorate the severe economic shock which the defaulting countries will suffer, and they will also have to control and limit the damage to their own banking systems which presently hold a significant amount of the ‘bad’ debt.”
So what to make of all the volatility? Mr. Singer shies away from hanging up the Doomsday clock. With a healthy dose of uncertainty, he says he’s not sure if the “current market volatility is the start of something big or just a spooky episode.” However, if the next financial crisis is indeed brewing, Mr. Singer says, it will not enter as a lamb:
“You should expect surprising transmission mechanisms, the tearing apart of vulnerable market connections and assumptions, and a whole new set of insolvencies and problems. There is no way to predict the shape and timing of it, except our guess is that when the next real crisis (not just a head fake) starts, it will play fast, very fast.”
Yet for all the bearish musings in the letter, there is one thing Elliott is bullish on: itself.
The fund said it is still finding significant opportunity in “structured products, readily available at cheap prices from banks that are still under pressure; securities related to distressed real estate in the U.S., Europe and Japan; and discounted claims in the Madoff bankruptcy.”
In defense of its size, Mr. Singer says its returns have not suffered as it has grown. Based on an in-house statistical analysis, the fund achieved its best performance in 2007 and 2009, when it was at its biggest.
It is also getting bigger. The firm, the letter said, is “currently in the process of raising additional capital.”
David Farr, speaking on Emerson Electric's 2Q11 earnings call (August 2, 2011)
“Now why did we call out last week in our orders that things are getting weaker? Because they are, they are weaker. We have always been very open in our communication to our shareholders and to our investors. And when we see fundamental change, we call it out. There's no reason to hide it. It's the facts and we did it. Our underlying orders grew only 6.5% for the last three months. That is outside the range that I have been talking about for several months, in the 7% to 10% range. And yes, it's against tough comps, but I saw fundamental weakness happening over the last 60 days.
“And then a couple days later, they announced GDP. GDP in the U.S. grew in the first half less than 1%. Let's get that said, less than 1%. You look at all the facts that have been coming out the last couple of weeks and the economics have been weakening. It's not new news. We have to deal with it. We have to position the company to deal with those things.
“Then we have a government situation, their inability to deal with the real gut issues of excess spending and debt. All we hear out of government is we're going to raise taxes. We don't like corporate planes. We're going to sue Boeing, one of the most strategic companies we have in this country, for building a new plant in South Carolina. We have no desire to really go after corporate tax reform, which would fundamentally change this country and encourage people to invest and reinvest and create jobs in this country, but rather demagogue and go after people that actually create those jobs, be it corporations and people that are successful. We have a difficult issue right now to deal with in this country, and the same is going on in Europe. They are in no better condition.
“So as I look at what's coming at us in the second half this year, I do not see the catalysts that would say that the economy will be fundamentally different in the second half than we saw in the first half. Maybe the gross GDP will grow a little bit more in the second half, but fundamentally there's nothing going on in the U.S. right now that would encourage corporations to ignore the excessive regulations coming at us, not to mention the new Dodd-Frank bill relative to whistleblowers or producing or mentioning what we have to do with minerals. We have to publish now what minerals we use. You look at the new healthcare bill, you look at last week we decided in Washington to raise the CAFE standards for the second time within three years on the day that we announced less than 1% first half GDP growth in the U.S. economy. I would say Washington is arranging the chairs on the Titanic, the way I look at it.
“So we're dealing with realism here in this company. We're looking at slower growth. We don't know exactly what that growth is. We will manage accordingly. Our orders in industrial work will stay up. I can't tell you right now what the second half will be. I can't tell you what 2012 is going to be. So don't bother to ask me because I will not tell you. If you ask me what 2012 is, the first thing I'm going to ask you is what is your forecast for the second half of GDP and what is your forecast for GDP in the first half of 2012? Let me know and I'll tell you what my forecast will be. As a company, we have strong operating cash flow. Our balance sheet is in great shape. We've made strategic acquisitions. We are integrating those acquisitions. We don't have a lot of acquisitions underway right now. I do not see a lot of acquisitions underway in the near term. We're using our cash to pay back a dividend. We just announced a record 55 years of increasing dividends. We've increased our share repurchase. We're now on track to do over $900 million of share repurchase, returning cash back to our shareholders. And we will continue to generate the earnings and the best growth we can in a very difficult market on a global basis and reinvest for future growth and creating shareholder value. The company will perform in a very difficult environment as we have. We'll set record levels of cash. We'll set record levels of earnings – of margins, and we will continue to drive forward. That's where we are right now. We are dealing with very uncertain times, and we will manage those accordingly.
“I feel good about where the company sits right now. We are performing at very high levels. All companies have issues we have to deal with, but we're dealing with them. Our price/cost is close to being in equilibrium, and we will be there in the fourth quarter. Our margins right now are running at very high levels, and we will set a record this year. And our earnings growth is good, as is our cash. So I want to commend the operating executives and the corporate executives for what they're doing in this very difficult time period. And we will play with the hand we're dealt with and we'll play the best hand we can, and that's where we sit. So now we can open it up for questions, but I will not talk about 2012 because I have no visibility into 2012 at this point in time given what's going on around this world, both in Japan, in the U.S., and in Western Europe. And that's where I sit. Thank you very much. The floor is yours.”