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Archive for August 2010

F Wall Street Hits #1 and Other Notes

with 2 comments

First, a big congrats to my friend Joe Ponzio, whose book F Wall Street is the number one best seller on Amazon.com in the investments category. Joe and I worked on a small number of projects several years ago, and, to the best of my knowledge, I was the first to write a guest piece for his web site.  More importantly, Joe is the real deal as an investor and among the nicest people I know.  He writes about investing with such clarity and insight that it reasonably makes the rest of us envious.

Second, I haven’t posted much recently; although, I have several items in draft.  So, let me bring you quickly up to date on the investments front.

I am increasingly concerned about the US economy, having crunched the numbers concerning the current accounts deficit.  With debt-to-GDP at over 90%, with the consumer, government, and the banking industry trying to de-lever at the same time, and with another potential leg down for the housing market, this recovery has the strength of a COPD patient on oxygen.  Add to this the looming challenges related to Medicare, the retrenchment by the federal government in their support to the states for Medicare and Medicaid, and the austerity initiatives in Europe and China, and you have the potential for a market crash, a la 1929. 

For those who are return-visitors to this blog, you know that I am not prone to overt pessimism, but the numbers are problematic and inescapable, and they prompted me to read Liaquat Ahamed’s Putlizer Prize winning Lords of Finance:  The Bankers Who Broke the World.  While the title might suggest a recounting of the 2007/2008 crash, it is actually about the central bankers in Europe and the US during the inter-war period between the end of World War I and the start of World War II — primarily focusing on the run-up to the market crash of 1929.

The lesson from that history is that the predicates of crashes are set long before the lit fuse becomes visible, and the result is, either, inflation or deflation — depending on the physics of international capital flows and the responses by government.  During that time frame, the challenges confronting England, France, and Germany were high levels of sovereign debt.  Germany owed reparations to England and France, and England and France owed war-time-funding debt to the US.  Germany chose hyper-inflation and England and France, to varying degrees, chose deflation.  Debt owed to the US and capital flows into the US created a speculative bubble in the stock market, which crashed when Germany and England defaulted and went off of the gold standard.  This led to margin account insolvency in the US, followed by bank runs and the downward spiral you learned about in school.

Now, recognize that, depending on whether you believe inflation or deflation is the likely consequence of current government policy, your investment decisions will differ significantly. 

If believing in the inflation scenario, you want to be in excellent companies with strong financial positions.  By this, I mean companies that have little debt (won’t take a hit if interest rates rise to keep pace with inflation and don’t require debt financing to sustain operations) and those that have pricing power for their products (can increase prices to keep pace with inflation).  If you are uncertain about which companies possess these attributes, read up on Michael Porter’s Five Forces to better understand the strategic competitive factors that sustain companies during challenging times (whether the challenge comes from the economy, government policy, decisions by the Federal Reserve, or competitors).

On the other hand, if you are in the deflation camp (personally, I’m straddling this fence and it is uncomfortable), cash is king.  When deflation hits, the value of cash increases.

Either way, cash provides flexibility.   If the market tanks and inflation follows, I’ll jump into inflation-resistant stocks, such as XOM, TEVA, FCX, etc.  If deflation hits, I’ll sit on cash or, better yet, invest in an ETF of stocks in India, China, or Norway (countries with growing economies and little sovereign debt); although, the 1929 crash in the US arrived despite our strong national balance sheet (suggesting that China and India are not safe, either).

Regardless, I’ve been increasing cash.  My concerns about the economy and uncertainties about whether we are likely to experience inflation or deflation, prompted me to do what I did at the start of the last crash — namely, sell any position about which I am not abundantly comfortable.  Although most of that has been accomplished, I may have some additional paring to do.   The result is that my cash position has gone from 10% to 45% , as the market moved up recently.  While I did realize some losses, profits significantly out-weigh losses, and our tax bill will reflect it at the end of the year.

The most significant profits were from the sale of my largest position — McKesson (MCK).  In my judgment, MCK is hovering around fair value, but that is not why I sold.  Instead, I sold MCK to make another purchase — a condo rental investment.

“Real estate!?!????” you must be thinking.  Yes, but it is a great value investment.  Let me explain.

The property in question was worth around $120,000 at the peak of the local market.  Since then, similar properties are selling for around $100,000.  The local market, by the way, is a small college town in the mountains, where student-rented condos and apartments are in short supply and the dorms are terrible.  To insure sale of the condo, the previous owners were offering it for $90,000, and, when it did not sell after a month, reduced the price to $80,000.  Still, it did not sell, because the banks are not lending.

We bought it for $70,000 in an all-cash deal, and still had difficulty securing insurance (such are the dysfunctions of the current economy).  Of course, the real estate market may decline further, but the market for student housing is favorable (the condo is within walking distance to the school and has its own covered bus stop), the school has an excellent reputation and is a magnate for students seeking a quality education in a great environment (minutes from hiking trails and ski slopes), etc.  Additionally, the previous owners renovated extensively (all new appliances and furnishings), and, because we paid cash, we confront no downside due to leverage.  By every imaginable measure, this was a value investment, where we bought at a discount to intrinsic value and with a nice margin of safety.

Now, honesty compels me to mention that our first renters are my son and the adorable young lady that tolerates him — so, I have every expectation that the property will be well maintained for at least the next three years.  They are, indeed, paying a competitive rent (with a small family discount), and Mom and I are not paying dorm or meal plan fees.  The swing in cash flows amounts to about $10,000 per year, which, over the next three years, will reduce our break even resale for the property to around $40,000 (before considering the time value of money and any maintenance costs). 

So, we bought a $120,000 property for $70,000, and break even is $40,000 in three years.

I should note that, since purchasing the property, we have bought back into MCK at about 10% or our prior levels.  While MCK is fairly valued, its future prospects are excellent (as a distributor of pharmaceuticals), due to the changing demographics.

Buffett is famously quoted as writing:

Over the [past] 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.

There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.

http://www.berkshirehathaway.com/letters/2004ltr.pdf
{Note: Extended quote due to desire to retain context. The emphasis is mine.}

Well, currently, there is no more fearful market than real estate, but fear, alone, is not sufficient to warrant investment. Fearful or not, demand a margin of safety, because, from time to time, the sky may really be falling … or on the verge of doing so.

Now, allow me to say that I have no special insight into how the market will perform this year or next year. The cards are stacked against us, but the timing of their fall is uncertain. In fact, they may not fall at all. Moreover, I have not turned into a market-timing guru — that is beyond my pay grade and competence. I know my limitations, and, if I forget them, my wife will remind me.

Instead, it seems abundantly clear to me that, as a nation, our debt challenges are nearly as great as following World War II (when debt-to-GDP was 120%, but most other nations were comparatively worse off and individual savings was higher). Today, the world economy is not limited to the US and Europe, and most American’s couldn’t buy War Bonds if compelled by law to do so. Surely, this increases market risk, and, if it increases market risk, the required margin of safety required by intelligent investors should increase appropriately. And that is why I’ve moved more prominently into cash and diversified by buying real estate (under unusually favorable terms).

As for the stock market, recognize that there are some exceedingly attractive values today. As Legg Mason’s Bill Miller recently noted, XOM is trading at uncommon values today, and, personally, I’ve been buying Cisco over the past week — how can you not buy when the company has 40+% market share, the next largest competitor has just 5% market share, the stock has been hammered in the market, and is selling below intrinsic value (by my estimations).

Regardless, I have more dry powder than usual, and that dry powder is available to short the market if necessary. When is shorting, as a hedge to protect long positions, appropriate? When the market exceeds the following ranges by 10% or more:

Wilshire 5000 — between 9970 and 12800
S&P 500 — between 1000 and 1300
DOW — between 8970 and 11520

If the news is dire and prompts these measures to decline substantially below the range or if the market significantly exceeds the high end of the range, it may be time to short. Otherwise, the market is just gyrating, as it always has.

This range is based on the convention that fair value for the market is between 70% and 90% of GDP, with appropriate conversions for the DOW and S&P 500. Beyond the problem of recognizing that ours is now a global economy, there are two further issues with this measure. First, the range needs to be updated as GDP rises or falls. This range is up-to-date as of the latest release, but it will quickly become dated; hence, the 10% buffer. Second, it is difficult to know when a decline below the bottom of the range represents a buying opportunity or constitutes a shorting opportunity. To do this effectively requires an assessment of the macro-economic steering winds, and that is a judgment call only you can make at decision time.

Finally, I should note that I have positions in all of the stocks referenced (XOM, TEVA, etc.), and, as always, this blog is not intended to promote buying or selling decisions by you as an individual investor. Do your own due diligence analysis, make your own investing decisions, and, if the market treats us unkindly, be adult enough to accept responsibility for your choices and realistic enough to recognize that the future is uncertain and predicting it accurately is, at best, difficult and, at worst, impossible. We (you and I) do the best we can with the resources available, and neither of us can know what can not be known.

Written by rcrawford

August 14, 2010 at 7:50 pm

Posted in General

RP Repost — Why the Critic(al) Popularity of Modern Art

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For some time, I’ve been a member of the art discussion forum, Rational Painting — which is devoted to the education and advancement of traditional painting and art education, with its primary focus on the Munsell system of color theory.  When not discussing color theory, postings and conversations address a host of other topics related to art, with the moderators meritoriously demanding contributions rich in additive content — rather simple expressions of opinion.

Recently, a high school art teacher (Shawn) noted:

When my students would ask me ( I teach high school art) how artists or art movements make it into the history books, I would tell them one way is that a bunch of artists get together to share ideas, maybe their work shares some recognizable features, they start to work in studios in a particular area and pretty soon it becomes seen as a movement and critics take notice. All of these factors are currently taking place in a sort of grassroots movement known under the umbrella term “Classical Realism”. I could give a tour of areas of brooklyn and queens in NY where you can find enclaves of artists with just that kind of energy taking place, yet the periodicals are completely ignoring it.

And I responded:

Interesting question – in the first post.

There are, in fact, two questions in it.  The first is “why is realism not more highly regarded?,” and the second is “why is there a current preference among critics for non-realism?”  I’m sure we can deconstruct both even further, but, as a thought exercise, lets look at these in their pure form.

Why is realism not more highly regarded?

One would imagine that realism would catch a break, given the training and precision required.  The problem is that realism, alone, is the foundation of artistic training under the traditional system.  It is the equivalent of K-12 and college at the undergraduate level – the base level of training through which every traditionally trained artist matriculates.  The work produced by students at all of the major ateliers is impressive – even to the point that they are taught the components of beauty (composition, lighting, color harmonies, etc.).  With such high standards common, there is scant basis for assessing the exceptional, in which the exceptional is defined by increasingly small and, to the untrained eye, imperceptible differences in performance.  And this gets at two weaknesses in art criticism.

First, performance skill is not a requirement for critics – whether the critic is professional or pedestrian.  The fine differences in achievement that distinguish the exceptional from the competent graduate may fly under the radar for both types of critic and fail to earn appropriate recognition.

Second, in a Woebegone world, where every traditionally trained graduate is above average, the differences are not only imperceptible, they can easily glut the market and become common place – especially, in markets large enough to support art critics (New York, Los Angeles, London, etc.).  The critic, however, relies on a meritocracy to sell snob-appeal, and, where no evident meritocracy exists (i.e., an obvious basis of differentiation from one piece of work to the next), one must be created.  Otherwise, the critic is unemployed.  Yes, the King (as critic) has no clothes and is poorly endowed, but this recognition is more along the lines of George Carlin’s Willie Water, the sportscaster who proclaims, “I call ‘em like I see ‘em, and, if I don’t see ‘em, I make ‘em up.”

For both reasons, you hear art critics argue that traditional realism is bland, lacks originality, “has been done before,” etc.  Well, not only has it been done before, it is done currently, and, because there is little designed-obsolescence in traditional painting (the damned things last 800 years), the market for new and resold traditional paintings confronts few shortages in the major markets housing critics.

During normal times, wheat, as a commodity, is poorly valued, even though a great baker can do wonderful things with it.  With the drought in Russia, and this weeks decision by the Russian government to ban exports of wheat (to meet the needs of domestic consumption), the price of this common commodity has gone through the roof.  Such is the power of supply and demand on price.


Why is there a current preference among reviewers for non-realism?

Among academics, Newtonian physics applies … especially the law “For every action, there is an equal and opposite reaction.”  Transfer this to professors, and you have “For every professor, there is an equal and opposite professor.”  The reason is that Nobel Prizes are not awarded to those who break no new ground or generate no new discoveries.  New discoveries, however, do not arrive often or easily, and the bulk of research published in peer-reviewed journals does nothing more than confirm or marginally advance earlier research.  Confirmatory studies are insufficient to propel an academic into the pantheon of respectability and high regard.  Publish or perish, however, is the route to tenure (job security), so publish they must.

More impressive and more highly regarded are studies that debunk some portion of another’s thesis, and Nobel’s go to those who, both, debunk and blaze new trails of thought and prove the correctness of their thinking.  This certainly holds for the sciences, but what about the liberal arts, where proofs based on the pure logic of mathematics are not available?

In the liberal arts, it is better to break new ground than not, even if the newly broken ground is devoid of nutrients.  While we may have differing views about the nutritional value of the following examples, Hemmingway’s sparse style of writing and Pat Conroy’s passion and fluency in describing the most base of human motives represented departures from the established norms when first published.  The value and utility of the Pet Rock, also comes to mind as the paradigm departure, where the new idea was more important than the nutritional value.

Now translate this to the art critic.  Living and working in a major metropolitan area and writing for an educated audience, the critic seeks the new in order to feed the needs and interests of this rarified reader – a reader who will not be impressed or intellectually satisfied with status quo art, no matter how competently produced.

This only partly explains the allure of modern art – which, for much (perhaps, all) of its 50+ years, was new and different but might not have been intellectually interesting in itself.  That is why the psychobabble explaining an incongruous piece of modern art soon became as important as the work itself.  Defecate into a dog-food bowl and call it modern art (a la a Duchamp’s ready-mades) and, no matter how modern the deposit or attractive the bowl, it falls short of “art,” even to the modern viewer.  It isn’t “art” until the artist, curator, or critic writes that it is a “commentary on the quality of information and education fed to an obliging public through the school system and news media.”

Now, it is easy to deride this reliance on commentary until comparing it to the Renaissance art from which academic realism originates.  The subjects depicted during the Renaissance largely focused on scripture (because the church was the most prominent and prolific paymaster).  Subjects were not limited to the old and new testaments, however, but extended to metaphors from antiquity, Dante’s Inferno, and subjects depicting the persistent themes of the human condition – fear, love, hunger, etc.  Because the populous of that time were largely illiterate, no written explanation of a work’s “intent” accompanied the piece, but, quite often, nearly every aspect of a piece possessed meaning – where the choice of plants populating the back ground and foreground were understood to have meaning.  Depict the manger scene with the hemlock plant growing in the background, and you have a commentary on the fragility and impermanence of life that foretells the crucifixion.

Today, we lack the rich nuance of metaphor – there is simply too much to learn in the way of new knowledge (since the Renaissance) to sustain that word-of-mouth tradition.  So, artist-intent and commentary is required to take a piece beyond the obvious in its meaning and depth … something few realists do today.  In fact, many realists avoid commentary – contending that the work should stand on its own or argue that they do not want to limit the meaning a viewer can productively derive from it.  This practice, however, deprives the critic of material with which to describe and “sell” the work’s criticism when reviewed, and it requires a certain level of resourcefulness by critics lacking the artistic creativity to produce their own work.

Further, any piece that simply depicts the standard range of emotions and perspectives anchors the piece on that which has been abundantly done before.  Shakespeare borrowed plots from largely forgotten stories first written in antiquity or took them from stories published in other countries and languages (even if not from antiquity).   His works, therefore, might appear fresh or novel to his unread audience, and, while Marlow and a small number of others could compete on quality, the market was not saturated with such fluent, lush, and quotable language.

What I find most interesting about this scavenger hunt for novel ideas serving as the foundation for art (whether the idea precedes or follows creating the piece) is that it leads to Lateral Thinking – linking two or more incongruous ideas, often from unrelated fields or disciplines.  This approach to creative thought comes from Dr. Edward DeBono, MD, back in the 1940s, but it has witnessed a renaissance of its own more recently.  Certainly, the Pet Rock of the 1970s (a sarcastic and cynical critique of branding and packaging that was as much a comment on the over-scheduling that made/makes pet ownership difficult for modern professionals) was lateral in thinking, but the reference to Newtonian physics at the start of this section comports with lateral thinking, as well.  It is behind many of the non-fiction works making the New York Times best seller list today, and you’ll find it littered throughout the works of Steven Levitt, Edward Tenner, Malcolm Gladwell, and Geoff Colvin (all mentioned on this board in earlier discussions).

This practice (lateral thinking) is interesting because it notes the extent to which modern artists will go to create “meaningful” work, and it notes the largely untapped next-steps to which realists and traditional artists can go to make their work intellectually competitive for critic(al) assessment – if seeking to do so.   Consider realists who have made this shift and done so successfully.  Wyeth, Kassan, Monks, Koons, and others (to different degrees) make such a connection.

For Wyeth, the connection was often explicit (paraphrasing, “This hill represents the death of my father”), while Kassan’s backgrounds juxtapose the softness of the human condition with the textures and graffiti of a starkly dispassionate urban setting, Monks separates the water-borne nude from dry observation with a shower curtain, and Koons takes Andy Warhol to a disconnected extreme of trivial kitsch, writ large and obnoxious.  Like their work or not (and there is little that connects any two), each conveys additional meaning through contrast and lateral thinking and each has achieved a measure of market recognition, popularity, and critical attention – providing the critic with more than “This is an allegory of _______.”

In every era, there are icons of beauty – from Cleopatra to Mae West to Betty Grabble, to Fara Fawcett, to [name your favorite of our time], and each, before suffering the ravages of time, may be described as “eye candy” – recognizing that there are male equivalents, from Cary Grant through Paul Newman and Brad Pitt or Tom Cruise.  With art, there is merit to producing pieces of incomparable beauty, and many on this board achieve an extreme of that virtue that can melt knees and make a change of pants necessary, and the critic may assert that each is the artistic equivalent of “eye candy.”

But, beyond this, I suspect the critic is more easily sold on works possessing “mind candy,” because they allow the writer to fill column inches with more than a factual description of the technique employed, the subject depicted, the redundant theme chosen, etc., and they seek mind candy with which to interest increasingly modern and savvy readers.  Certainly, New York readers who purchase art pride themselves on the quality of their education (valuing it so highly that they allow their children to be interviewed for entrance into private grammar schools) and consider themselves smarter and more advanced than their counterparts in the heartland.  Los Angeles, and its art community, pride themselves on their creativity – seeking the New New Thing, in a culture influenced by Hollywood.  The elite of Atlanta, Chicago, San Francisco, and London rarely accord their success to pure dumb luck or, with the exception of Warren Buffett, declare their success follows from an average intellect or run-of-the-mill education.  Snob-appeal does not exist in a vacuum, where Lenny Bruce and Jerry Clower are deemed equally “important.”

And, beyond noting that these are the consumers of fine art, they are also the consumers of art criticism, to which the critic is compelled to pander if seeking professional longevity.  And this raises the question of whether, as an artist, you are prepared to pander (sell) to the critic.  Some may view it as a survival necessity in a competitive and recession-exposed profession, while others may place principle before purse (or view it as a contest between principle and purse).  The more interesting question, however, may be whether the realist, by dent of a psychology that values precision, tradition, technique, and attention-to-detail (left brain qualities) can readily connect the work to a right-brained explanation that is lateral in its construction.

Lastly, do not take this for a recommendation urging a change of style, approach, or philosophy.  There is nothing here that goes beyond seeking an answer to the original question and the two questions in my deconstruction – namely, why don’t critics value representational art more and why do critics favor “modern” art above the traditional.  Moreover, while presented as a sequence of assertions, this has been a thought exercise about which I am anything but certain.  It may be wrong in part or entirely, and it certainly possesses the detriment of opinion … as, unquestionably, will be opposing views.  But, to the extent that may explain the psychology of professional critics, it may also be worthwhile as a thought exercise, and I’d enjoy reading alternative explanations.

Written by rcrawford

August 8, 2010 at 9:39 am

Posted in Art