This past month Rich had the opportunity to attend the annual conference of the CFA Institute. This 4 day event, held in Vancouver, BC., included financial analysts from all over the world and venues for future conferences include Edinburgh & Singapore (with Orlando, Boston & Chicago thrown in as well).
There are many hotels that offer various complimentary amenities (a bath robe, slippers, chocolates on your pillow, etc.). The Marriott Pinnacle in Vancouver provides an umbrella in the closet. Although Vancouver is a beautiful place, the Marriott was correct…. it rained every day but one. Fortunately the conference was conducted indoors and the content of the conference was phenomenal. Here are some of the hi-lights.
The most interesting speaker was Nassim Nicholas Taleb, author of “The Black Swan, The Impact of the Highly Improbable” (www.fooledbyrandomness.com). As humans, we tend to make all our assumptions based upon experiences and things we know. We would always assume all swans are white…..unless we saw a swan that wasn’t white. Events that Mr. Taleb classifies as Black Swans are events that:
1. Are beyond the realm of our expectations.
2. Have a significant impact
3. After the event, we concoct reasons that make the event seem predictable.
An obvious example of a Black Swan of this decade would be the terrorist attacks on the World Trade Center and the Pentagon. Another example was the stock market crash of 1987. Prior to October, 1987, the largest one day change in the stock market did not exceed 10%. Therefore, one would assume, after 90+ years of stock market history, we would never experience a stock market move in excess of 10% in one day. But on October 19, 1987, the stock market declined more than 22%!
Mr. Taleb warns that the potential for financial Black Swans today are greater. This is because technology has “linked” so many large financial institutions to each other. Many years ago, you could have isolated bank failures without fear of it being a systemic problem. That is not necessarily the case today and probably explains why the Federal Reserve chose to “rescue” Bear Stearns. Allowing Bear Stearns to “go under” might have caused a chain reaction that the Fed did not want to deal with (a Black Swan). Mr. Taleb said there were (and still are) many financial institutions playing “Russian Roulette” just like Bear Stearns was. Just because you were not the one holding the gun when it went off does not mean you were not stupid for playing the game.
- Janet Yellen, President and CEO of the Federal Reserve Bank of San Fransisco was one of the main speakers Tuesday morning. The focus of her presentation included:
- The financial turmoil and credit crunch
- The downturn in housing prices
- The surge in commodity prices
She said a “bubble like” situation in real estate developed due to very low longterm interest rates and the rapid growth in sub-prime mortgage lending. Investors were willing to accept meager rewards for excess risk. How did this happen? The securitization and financial engineering of mortgages combined with up front origination fees that undermined strong underwriting incentives (in other words, just about anybody could get a mortgage without any down payment). Institutions in the “shadow banking sector” (they act like banks and resemble banks but are NOT banks) sought to increase leverage and increase yield. In addition, there was an over-reliance on credit ratings given by traditional, reputable ratings agencies such as Standard & Poors and Moodys. She conceded that lack of supervision by regulatory authorities was a contributing factor.
Sub-prime mortgage delinquencies continue to rise. Homeowners can’t refinance if the value of the residence has declined and she expects housing prices to decline an additional 15% or more over the next year.
As prices for oil, metals and many agricultural commodities have doubled in the past 12 months, they are not yet seeing any evidence of increasing inventories. If you define inflation as “personal consumption expenditures”, it is clearly rising. However, the Fed does not think we are headed into a period of “stagflation” (high inflation and weak growth).
She only noted one positive aspect of our economy today….U.S. net exports are a source of strength to our economy.
David Beatty, CFA, Managing Director of the Canadian Coalition for Good Governance, spoke about corporate governance. He pointed out that many publicly traded companies use a “plurality” voting system when shareholders are voting on the nominees to be on the Board of Directors. Under the plurality voting system, the nominee need only receive one vote “for” to be elected (or reelected). This is why so many bad Boards of Directors manage to stay in place. Some companies use a “majority” voting system, whereby the nominee must receive a majority of the votes cast in order to be elected. At BCWM, we vote all the proxies for shares under management. Whenever there is a proposal to adopt the “majority” voting system, we vote “for”.
An informative presentation was given by Henry Groppe of Groppe, Long & Littell, an Oil and Gas Analyst and Forecaster from Houston, TX. I’m not positive but I think Mr. Groppe said he has been in the oil business since 1945. Although he ultimately sees crude oil production declining in every country except Canada, he said that currently, based upon production and demand, he feels the price of oil could drop to between $70 – $80 per barrel. He stated that higher prices are NOT due to demand from China and India. Higher oil prices are a result of a reduction in supply by the Saudis and the Saudis are now increasing production.
After returning home, we have watched crude oil trade as high as $135 per barrel and gasoline at the pump as high as $4.00 per gallon. (A small but not insignificant piece of good news – on May 20th, the U.S. Energy Information Administration announced that imported oil comprised 57.9% of oil consumption in the first three months of this year, down from 58.2% last year….the first drop in that number since 1977).
On May 15th, the Organisation for Economic Co-operation and Development (OECD) announced that a composite of leading economic indicators points to a downturn spreading to most parts of the world in about six months. Since an increase in exports has been the ONLY thing keeping the U.S. officially out of a “recession”, this is very bad news. A downturn in Europe, Asia and South America would likely have a negative impact on exports.
An anecdote on a more local level – I ride my bicycle several times each week for exercise. I ride through several neighborhoods and I always ride the exact same route (about 3.6 miles, nothing serious). Last summer I started counting the number of homes for sale on my route. Before I hung my bicycle up for the winter, the highest number of homes for sales reached 8. Several months later after warm weather returned, I started riding again. The other day I counted 25 homes for sale, TRIPLE the number for sale last year. What is it like in your neighborhood?
What does all this tell us? If Ms. Yellen is correct and real estate values continue to decline another 15%, we believe this will continue to adversely affect consumer demand. And as long as the consumer has to pay $4 per gallon for gasoline, his/her ability to purchase discretionary items will be curtailed.
It was reported in the Wall Street Journal that the lenders own about 660,000 foreclosed homes in April, up from 493,000 in January and 231,000 in January 2007. Lenders typically are not interested in “owning” real estate and will act quickly to get rid of it. We feel that real estate’s effect on consumer demand may last a very long time. However, if Mr. Croppe is correct and oil drops in price back to $70 per barrel, that would have to be considered a positive for consumer demand (provided the drop in price translated into a drop in price at the pump). We would have to re-assess our investment position as oil approaches $100 per barrel. It may be that a recession is so entrenched, that a drop in the price of oil is not enough to revive it.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.