Trick? Or Treat?

Portfolio performance through 09-30-2010:

+9.6% for the third quarter,

but negative over the past three years.

Maine state employees and retirees got some good news earlier this month when MainePERS trustees reported a gain of 9.6% in the pension fund's market value from June 30 to September 30. A string of quarters like that will go a long way toward closing the gap (estimated at over $4.4 billion) between the projected benefits due future retirees and the resources currently expected to be available.

But the state's investment in the financial sector continues to diminish returns. Two large equity holdings, JPMorgan Chase and Bank of America, have dropped out of the portfolio's Top Ten, not because shares have been sold, but because the shares held (over a million shares of JPM and 2.5 million shares of BAC) have underperformed relative to other investments. Since financial-sector stocks peaked on April 15, JPM's stock price has fallen by 21.9% (as of last Friday's close) and BAC's by twice that, 42.4%. That's over $20 million up in smoke.

According to a MainePERS spokeswoman, MainePERS domestic equities are "100% passively managed." In other words, fund managers are not in the business of picking winners and losers. They buy the entire market and hope for protection through diversification. That's fine if the market goes up, not so fine otherwise. With the broad economy working its way through a painful transition, what we are left with is not a stock market, but a market of stocks. Some will advance, but most will stagnate.

How are the Ivy Leaguers doing it? This is how:

Notice that Harvard allocates 33% of its endowment portfolio (as of June 30, 2010) to publicly traded stocks. MainePERS, by contrast, has over 63% in stocks. MainePERS knows that it is overexposed to equities and aims to reduce its allocation to 55% eventually, still two-thirds higher than Harvard's. Harvard has also gone to 2% cash as a way of improving the "flexibility of the portfolio we are managing today," part of its renewed commitment to "attend closely over the last two years to liquidity, capital commitments, and risk management." MainePERS? 0.5% cash on the way to zero. Voilà some of the differences between active and passive management. "De-risking," Harvard calls it. Yale's exposure to public equities is even less--16% on June 30, down from 34% the year before.

In an environment which calls for sharpshooters with rifles, not shotguns, MainePERS may have the wrong weaponry.

[update, 11-04-10:]

Check out this piece on Bank of America. Remember, if you are a Maine taxpayer or MainePERS enrollee, you own this company.


[update, 11-07-10:]

According to former bank regulator William K. Black, "putting Bank of America into receivership is the proper remedy for its substantial violations of the law and for its continuing reliance on unsafe and unsound practices. Outside reviews have documented the most extensive and financially harmful violations of law and unsafe banking practices and conditions in history." Black further states that "demands by investors that Bank of America repurchase loans and securities sold under false 'reps and warranties' may cause exceptional losses." I repeat, Mainers own 2.5 million shares of of this zombie.

Dressed To Kill

Jeremy Grantham,

Chief Investment Strategist, Grantham Mayo Van Otterloo & Co.

October 2010 Quarterly Letter

[excerpt:]

"If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage inflation. Better yet, I would limit its activities to making sure that the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times – the Greenspan/Bernanke put. It would be a better, simpler, and less dangerous world, although one much less exciting for us students of bubbles. Only by hammering away at its giant past mistakes as well as its dangerous current policy can we hope to generate enough awareness by 2014: Bernanke’s next scheduled reappointment hearing."

Complete commentary viewable here.

Doing the Math

[click to enlarge]

Regular readers of this blog know that I am no fan of the banksters on Wall Street. They are the ones who securitized subslime mortgage loans (worth hundreds of billions of dollars in face value) and sold them to inattentive investors, thereby fueling a housing bubble and stunting the productive economy. Despite this malfeasance, they were bailed out by Congress in 2008 with direct injections of taxpayers' money. They benefited further when they were allowed to offload toxic assets onto the Federal Reserve's balance sheet. Investors, assured by such machinations that the banks had backup, plowed even more money into the sector by buying up new stock issued by the banks.

I have said all along that such investments are risky, and I have been taking the other side of that trade (explained here). The banks, facing declining revenues, have been generating "profits" by drawing down their loan-loss reserves even as loan delinquencies accelerate. To make matters worse, they may have to buy back tens of billions in subslime securities because of faulty documentation. Write-downs and write-offs will follow. The banks are insolvent; once investors figure this out, there will be a rush to the exits.

Bringing investors into the light is Branch Hill Capital, which has compiled a Power Point about to go viral. The slide show picks on Bank of America (as have I, many times--try that Search bar above), but could have selected any one of the Too Big To Fail banks. Branch Hill's advice? Go long the monoline insurers, go short the banks.

There. I just made your week.

Fed Continuing Down Dangerous Path

John Hussman,

"The Recklessness of Quantitative Easing"

[excerpt:]

"Businesses and consumers now see their debt burdens as too high in relation to their prospective income. The result is a continuing effort to deleverage, in order to improve their long-term financial stability. This is rational behavior. Does the Fed actually believe that the act of reducing interest rates from already low levels, or driving real interest rates to negative levels, will provoke consumers and businesses from acting in their best interests to improve their balance sheets?...

Despite the probable lack of measureable benefits, further QE poses significant risks. It has already triggered a steep decline in the exchange value of the U.S. dollar, and threatens a destabilization of international economic activity, a loss of confidence, and the creation of a "boom-bust" cycle threatening to choke off any economic recovery that does emerge....

One critical question deserves far more attention. After the Fed engages in another round of QE, how will it unwind that position?...It is unlikely that QE will result in a significantly greater use of existing slack capacity and labor in the U.S. economy. But several years from now, as the U.S. economy recovers (no thanks to the Fed, but simply by the emergence of new technologies and markets through innovation), the Fed will have no easy choices. Attempting to sell massive amounts of debt into an expanding economy will risk pressuring interest rates higher and choking off the recovery...."

Complete commentary viewable here.

Eleven Days Remaining

Candidate interview

Lewiston Sun Journal

10-22-2010

Thursday Threesome

The Long Way Around

Pushing On a String

Richard W. Fisher, President

Federal Reserve Bank of Dallas

on the need for more quantitative easing:

"Given that we at the Fed are mandated to maintain price stability and create the monetary conditions to encourage maximum employment growth―at a time when inflation is 'somewhat below' what the Committee as a whole judges appropriate―I instinctively understand the impulse to put the monetary pedal to the metal to try to move the needle on employment growth. And yet the efficacy of further accommodation at this point has yet to be established....

Of course, if the fiscal and regulatory authorities are able to dispel the angst that businesses are reporting, further accommodation might not even be needed. If job-creating businesses are more certain about future policy and are satisfactorily incentivized, they are more likely to take advantage of low interest rates, release the liquidity they are hoarding and invest it robustly in hiring and training a workforce that will propel the American economy to new levels of prosperity, rendering moot the argument for QE2. The key is to remove or reduce the tax and regulatory uncertainties that act as an impediment to businesses responding to an increase in final demand. I think most all would consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet....

There is a great deal of legitimate debate still to take place within the FOMC on the subject of quantitative easing and the pros and cons and costs and benefits of further monetary accommodation. Whatever we might do, if anything, must be consistent with long-term price stability and not add to the nightmare of confusing signals already being sent to job creators."

[Entire speech viewable here.]

Tuesday Twosome

Paul Simon and Art Garfunkel

The Boxer

Competing for Students

"This shows the enormous demand for school choice. The competition really injects a level of accountability into the system."

--Jamie Gass, director of the Center for School Reform at the Pioneer Institute

Under a Massachusetts law enacted in 1991, students can attend public schools in any district that accepts outside students and has seats available. Host districts are often enticed by the $5,000-per-student subsidy they typically receive from the students’ home districts.

Complete Boston GLOBE story here.

The Road to Stagnation

Take this 60-second ride, see where you end up:

[Click on the yellow stripe once it starts moving for a wider view.]

"The regulatory impact on the business community is pervasive, insidious, and needs to be exposed," said U.S. Chamber of Commerce President Tom Donohue (below) in Des Moines last night. "It is suffocating the entrepreneurial spirit." The Chamber will spend $75 million backing pro-business candidates in the November elections.

Curing Our Addiction to Growth

Sustainability expert Tim Jackson talks about how to evolve from "spending money we don't have on things we don't need to create impressions that won't last on people we don't care about." [20 minutes]

Race To Debase, Take 3

Dominique Strauss-Kahn

Managing Director, International Monetary Fund:

"There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery . . . Any such approach would have a negative and very damaging longer-run impact."

Financial Times, 10-05-10

Tuesday Twosome

Graham Parsons and Emmylou Harris

Love Hurts