Sunday, January 28, 2007

My Current Perplexions

I realize that I have a dangerous bias--one that gravitates toward the calamitous. I'll credit my work experience with that as I have largely had to envision the worst and prepare for it. While a useful skill in doing turnaround work, I'm not sure how helpful it is in investing.

That the market climbs a wall of worry is something that I understand more fully now than I did as much as a year ago. I admit that I have this absolute dread of being caught fully invested in the next downturn. Though a distinctively unsuccessful strategy for me was to bet on the much anticipated decline as opposed to being hedged against it.

I cannot help wondering if my increased understanding (though still bumbling and nascent) of macro issues has done anything more than render me incapable of making prudent investment decisions. Nevertheless, I'm going to continue to process information as well as I can, and be devoted to my continuing tutelage. And I firmly believe that this is an important time to try to figure out how the winds are blowing, as it is my belief that there is some shifting of gears regarding the economy.

I was listening to Jim Puplova, and there were a few things discussed that I found interesting.
  • Volatility: increased volatility will cause credit contraction.
  • Dollar is mostly tied to whether or not foreigners want to hold USD's. Why would foreigners want to continue to invest in a slowing economy? Also, to affect the dollar, they will only need to make changes at the margin.
  • We've not had a consumer led recession in more than 10 years.
  • Central Banks have lost control over money supply (I also note that Don Coxe said this as well 05.29.06). Hedge funds are their own bank--anyone can borrow @ Fed funds rate.
  • Fed will counter contraction that affects consumer (through lower rates).
I still do not believe that housing issues have shown up in the employment numbers--and I continue to believe that is due to undocumented workers. That would result in an understatement in unemployment claims as currently reported.

I do not believe that loan loss reserves have yet been hit with any credit degradation in their loan portfolios. I still find this odd, but I don't think my worry is wrong, it is just early! I have a very small position in Firstfed Financial Corp (FED). Here's a recent release:

"Amortization, which results when unpaid interest earned by the Bank is added to borrowers' loan balances, totaled $215.8 million at December 31, 2006, and was $62.6 million at December 31, 2005. Negative amortization increased by $38.0 million during the fourth quarter of 2006 and $153.2 million for the year ended December 31, 2006. Negative amortization has increased over the last two years due to an increase in short-term interest rates.

A $3.0 million loan loss provision was recorded during the fourth quarter of 2006, the same as the third quarter of 2006 and less than the $4.0 million recorded during the fourth quarter of 2005. A loan loss provision of $12.4 million was recorded for the year of 2006 compared with $19.8 million for the prior year. Net loan charge-offs totaled $90 thousand and $190 thousand for the fourth quarter and year of 2006. This compares with net loan charge-offs of $36 thousand and $1.4 million recorded during the comparable periods in 2005. The ratio of non-performing assets to total assets was 0.21% at the end of 2006 compared with 0.05% at the end of 2005."

I truly found the loan loss reserve decline surprising. However, note that the ratio of non-performing assets to total assets increased 4 fold (though these rates are still historically low). So either the worst is behind us or there is more to come. I'm in the more to come camp.

I'm keenly aware that I may be letting my bias interfere with the processing of the evidential matter before me. I was right regarding interest rates all of last year, so I'm holding that one insight (but an essential one that much smarter people were taking the other side of) out that I'm not a complete dunce.

Roger Nusbaum had a nice segment on patience. (And Nona, I pulled out my 18th Century Lit book with a section on S. Johnson and one of his Rambler quotes on patience--it's unintelligible to modern readers, so I'm not even going to quote it!) . I was inspired by Roger's counsel on patience. Accordingly, my goal is to cultivate greater confidence in my thinking. I have undermined my confidence through my failing to be patient in allowing what I expect to unfold happen in its due time. The snippet from FED is not yet showing (except for the non-performing assets ratio) any stress fractures. And even though the non-performing asset ratio is increasing, for all financial institutions, this ratio is at historic lows. You'll remember that I posted a graph from FRED here that shows this ratio. We'll continue to watch this. And by June 30, I will expect to engage in either a minor gloat or a confessional on my continuing foolish thinking.

3 comments:

Anonymous said...

I just found this article.

http://www.slate.com/id/2158085/fr/flyout

A very successful money manager I know keeps clients' money in selected index funds.

When I sent him the above link, he immediately wrote back to thank me and advise that he's going to reprint the item in his upcoming client monthly letter.

It amazes me that people pay him to select passive investments -- index funds, no less!! Over time, I've come to think that maybe he's on to something....

I think there's something in the genes of a creative person -- and you're creative, Leisa -- that prompts him or her to want to invest actively, not passively. For some of us (I put myself in this camp), I think active investing may not be as successful a strategy as simple (*groan*)indexing or (*gasp*) buy and (mostly) hold.

Again and again -- and with remarkable consistency -- my biggest mistake has been selling too soon.

And while I can say that last year I outdid Bill Miller's 2006 performance (!) I didn't do so by a lot. I had nearly half my money in cash because, frankly, I was timing the market. Correction: I was ATTEMPTING to time the market. You might say the market "won".

Your comment on patience: If we think about it, indexing and (mostly) buy and hold approaches are examples of applied patience.

But you know the old prayer: "Lord, please grant me the gift of patience -- and I need it RIGHT NOW."

Leisa♠ said...

Nona, thanks for the article. In fact, I read it over the weekend. I do not disagree with his points. But the article was long on admonishment and rather short of facts, and I believe his point would have been more powerful had he provided some specifics.

And...no matter how well you are indexed, when the market tumbles, you are going to go along for the ride.

Anonymous said...

"And...no matter how well you are indexed, when the market tumbles, you are going to go along for the ride."

And no matter how well selected one's portfolio, when the market tumbles, so will the portfolio. The article was merely pointing out that while it's always been hard to outsmart the market, now it's REALLY hard to do that.

Also, I think I can dig up some of the articles about top fund managers who keep all their personal money in...index funds! Same reasons as described in the article apply.

I have to ask myself: am I trading a reduced net worth for the "fun" and challenge of buying and selling? The true answer, I blush to admit, is Yes. At least, that has been the answer.

I don't think I could settle for an index fund approach, but I am working out a portfolio that will be a (mostly) buy and hold portfolio. Here are the kinds of companies I'm looking for: a history of steadily rising earnings and steadily increased dividends along with steady stock price appreciation. Those three elements are my "holy trinity" although I know that occasional stock price declines (aka "buying opportunities") are to be expected from time to time.

All suggestions/recommendations are welcomed -- indeed, they're encouraged!