Value Investing using Economic Value Added (EVA)

GDP Minus Government Spending: Which Cliff Would You Jump Off?

Today's better-than-expected -1% GDP was tempered, somewhat, by the staggering 11% spike in Federal Government spending (hello stimulus!). Today's chart looks back at the Y/Y GDP change with the same number sans government spending. As you can see from the divergence, the government boost provides a big help.  Joe Weisenthal and Kamelia Angelova

CHART OF THE DAY: Thank God For Government Spending.

Government Spending - with the exception of necessary and productive infrastructure project and financial rescue spending - does very little for GDP.  The difference between the blue line - GDP with Govt spending and the red line  - GDP without govt spending - is the magnitude of the impact of stimulus at one quarter in time.  Blue or red; seems horrible either way.

BERK

Tax Burden of Top 1% Now Exceeds That of Bottom 95% - or You Can't Eat Percentages!

The government pays for stuff with dollars.  It takes dollars from citizens through the income tax and transfers those dollars (after it goes through the government filter where billions are sucked out to pay for the bureaucrats, lobbyists and politicians plus their staffers).

You can't eat percentages.  Percentages are ratios. Tax rates are ratios and percentages.  Here's the news: When you raise tax rates - percentages- you do not always get more to transfer to those that do not have to create, risk, employ to earn, whatever dollars those ratios end up representing.

Here me now and here me LOUD!  Raising tax rates or lowering tax rates does not make a tax system more or less fair - more or less progressive.  Tax systems are for efficiently collecting revenue for the government.  Tax rate changes have perverse unintended consequences.

So why do I hear about tax cuts for the rich and how George Bush's tax cuts for the rich created the deficit that Obama inherited - Bull S*?$t. 

There were tax rate cuts but there were not any tax cuts.  Tax rate cuts do not mean that the wealthy pay less taxes. They only pay less if everything stays the same - and nothing ever stays the same.

Since the middle of 1987 after the Reagan "tax rate cuts for the rich"  - the rich have been paying - or sacrificing ever since.  The Tax Foundation - Tax Burden of Top 1% Now Exceeds That of Bottom 95%.

Nobody but nobody should be able to ever say again that the rich got the benefits while the poor suffered. On the contrary - the rich in total paid a greater share of total dollars to fund the other 95% of DOLLARS collected every year since 1987....

...the IRS data shows that in 2007—the most recent data available—the top 1 percent of taxpayers paid 40.4 percent of the total income taxes collected by the federal government. This is the highest percentage in modern history. By contrast, the top 1 percent paid 24.8 percent of the income tax burden in 1987, the year following the 1986 tax reform act.

Remarkably, the share of the tax burden borne by the top 1 percent now exceeds the share paid by the bottom 95 percent of taxpayers combined. In 2007, the bottom 95 percent paid 39.4 percent of the income tax burden. This is down from the 58 percent of the total income tax burden they paid twenty years ago.

To put this in perspective, the top 1 percent is comprised of just 1.4 million taxpayers and they pay a larger share of the income tax burden now than the bottom 134 million taxpayers combined.

1.4 million people pay more and more dollars - screw tax rates - than 134 million people - Is that fair?  Mind you I am not complaining - I am not in the top 1% but I know that I will only have a chance to become one of the 1% if there are incentives for everyone to win!  Soaking the rich, the fat, the skinny - is immoral, unfair and un-American.  AND IT DOES NOT WORK!

 HT:CARPE DIEM

I'm Berk and I am not taking it anymore! 

Big Bonuses and Risk Taking

My friend Marc Hodak writes here about Congress' attempt to eliminate perverse incentives at too big to fail firms.  Of course, Congress does not even know what they are trying to control.

He examines 7 questions that the compensation information firm Equilar finds that companies are asking in their recently filed proxies.  Marc is OK with six of the questions but one stands out as a "teachable moment" to use a recently popular phrase.  He writes:

“Do large maximum bonus opportunities promote risk taking?”

Of course they do.  Is that supposed to be a bad thing?  Entrepreneurs have unlimited bonus opportunities–thank goodness.

The question of a maximum bonus opportunity is simply the wrong question when talking about reward systems.  The question they should be asking is whether steep bonus opportunities are combined with zero bonus opportunities.  All the governance risk faced by a company is in the area where the participant would earn no bonuses unless they can get up into the green zone of bonus payouts with an all-or-nothing, double-down, longshot bet.

So, guess which of those questions most congressmen view as the most critical in determining “excessive compensation risk?”  Yep, the risk that business executives might get paid too much.

Why is any company public? - I often wonder. 

Also, my readers familiar with the incentives at hedge funds will understand that Marc is talking about the free "trader's call option".  When hedge fund managers are in the red zone - where they do not earn performance bonus-there is no penalty, no clawback.  Therefore, like Marc says, the manager has an incentive to take much more risk than "normal" to get a near-term large pay-off. 

There is no free lunch though.  Incentives become drastically misaligned in the red zone as the risk taking incentive is strong for the manager but not necessarily as big for the client.  These asymmetric (mis-aligned) incentives have always been my main criticism of the typical 2% and 20% of profits fee structure. 

It is also why many EVA companies have tried hard to implement bonus reserves where excess near term performance bonuses are held in reserve to make sure performance improvements are sustained in subsequent periods.  This way Boards more easily replicate ownership-like incenitves deep within the organization.  If there is risk of loss then managers can have large bonus opportunities.

BERK

Doom? Or Boom?

In this post  (Bret Swanson - Maximum Entropy » Blog Archive » Doom? Or Boom?.technologist Bret Swanson gives us his slides from a recent presentation in which he tries to measure the growth of consumer bandwidth and to show how the pace of technological change in other areas is likely to continue remaking our world for the better.

Do we really understand just how fast technology advances over time? And the magnitude of price changes and innovations it yields?

Especially in the realm of public policy, we often obsess over today’s seemingly intractable problems without realizing that technology and economic growth often show us a way out.

And this is the BIG question during this critical moment in history.  Is growth good or bad?  If growth is good then how will we fuel all that growth?  Resources are finite, especially energy. 

And right in time, famed money manager Jeremy Grantham predicts slow economic growth for at least seven years.  But that's not even the worst part, he says here

...we are simply running out of everything at a dangerous rate. We apparently have trouble processing numeric issues of this kind, and this missing faculty will cause considerable grief. We do not understand the implications of exponential or compound growth rates: the main implication being that they are impossible to sustain.

Who is right?  I am not willing to bet yet because all near certainties seem to have disappeared lately.  Will growth rescue us if we let it?  Or are we doomed to live a life of increasing scarcity and higher prices where our children live a much poorer life than we did?

It seems that the nation at a time of peril had chosen the shrinking pie path.  Lately, it seems that we are getting a lot more pessimism and anti-growth rhetoric than we bargained for.

What do you think?

Berk

India Questions the Benefit of Global Warming Policy

Since the beginning of the financial panic in September world leaders, central bank chairmen, economists and business people have warned policy makers not to make the same mistakes that were made during the Great Depression or else we would suffer the same fate.

Specifically, policy makers must not:

1. Restrict credit by reducing the money supply,

2. Try to balance the budget - timely and targeted deficit spending and tax decreases are in order; and

3. Initiate protectionist measures - many observers blame U.S. protectionist measures like The Smoot-Hawley Tariff Act of 1930 which raised tarriffs on thousands of imported goods. The retaliatory tarrffs by U.S. trading partners reduced American exports and reduced jobs in the U.S. despite the tarriff's intent on protecting those jobs.

The Federal Reserve has saved the day in my view - but it has come at the cost of "burning the buck" - increasing bank reserves and money of zero maturity - so the banks can recapitalize themselves. The Fed has avoided the major policy mistake made in the Great Depression.

Unfortunately, Congress and the President are making major policy mistakes that will probably reduce "normal" levels of growth after the recovery.  Few will argue that the $787 billion stimulus bill was "timely" or "targeted", for instance.

And now Congress and the President are committing the original sin of protectionism.

Indian Environment Minister Jairam Ramesh informed Secretary of State Hillary Clinton, in the country for diplomatic talks, that India would oppose any push for legally binding carbon emissions caps. Earlier this week, he said:

There is simply no case for the pressure that we, who have been among the lowest emissions per capita, face to actually reduce emissions. And as if this pressure was not enough, we also face the threat of carbon tariffs on our exports to countries such as yours.

The climate-change bill that passed the U.S. House on June 26 calls for carbon-based tariffs if countries like China and India don’t adopt their own carbon controls by 2020.  Unintended consequences for sure as the Heritage Foundation's Foundry Blogexplins:

Perhaps most alarmingly, the announcement raises the prospect of a protectionist policies with India that could exacerbate the adverse economic effects of a cap-and-trade program. The Waxman-Markey global warming bill requires the implementation of carbon-based tariffs if China and India fail to implement their own emissions regulations by 2020. If and when that occurs, India will likely retaliate with tariffs of its own.

Ramesh needed to point out that global environmental policy must “[take] note of the special concerns of countries like India for continuing with their path of economic growth with the objective of poverty eradication.”

Now poverty eradication is one of those global initiatives that I can get behind.  Ramesh is implicitly saying that emissions caps imposed by the richest countries will cost too much - unacceptable hardship for India's poor. 

I have been arguing (latest here) that carbon trading schemes like cap n trade impose too much economic cost for the probability adjusted benefit.

India seems to get it - we should follow their lead.

Faster please.

BERK

"We're focused on profit-share, not market-share"

Back in February of this year Jim Cramer shouted, “Sell, sell sell Dell.”  Just the other night I heard him call DELL a "horrible company - worst in class "- or something like that.  How does he decide how well a company is doing?  or what is a good or bad company?

It seems that Cramer is just the tip of the EPS (expectation) fanatics spear.  It's too bad (or good from our prospective) because he gives the rest of us cheap stock to buy.  To this crowd, if a company does not let the market know whether or not they will meet or exceed analysts' estimates for EPS then they are doing a bad job.  And heaven forbid they miss expectations - that's a bad quarter, of course. 

The chart below shows that DELL is a very profitable company.  Are there challenges to its competitive advantages? - yes.  Does that mean that DELL is done? - no. Even during this recession DELL has cash returns on capital well above its cost of capital.  That is the definition of a value creating business model.  We noticed that DELL's economic profitability has eroded over the last fifteen years, but we also note that it is cyclical.  However, the long run cash returns above the capital costs are still quite large and they do not indicate that DELL is simply a commodity producer - commodity producers by definition have trouble earning much more than their cost of capital. 

Conclusion: DELL's competitive advantages have eroded a bit over time, but the company is not a "bad" company with a "bad" business model.  On the contrary, DELL is highly profitable company with important opportunities for increased profitability and new growth areas - consumer, Asia and services.

It's clear that DELL understands how to create long-term shareowner value.  It is not about your market share or level of earnings or how many quarters you beat analysts' guesses about your EPS - it is all about how much value you deliver on a per share basis.  Dell's CFO Brian Gladden made it clear by telling Bloomberg that they are not interested in buying Acer for the market share accretion - that's not the objective of a value-aligned company. Value-Aligned companies' objective is to create intrinsic value per share. 

But as Dell CEO Michael Dell told a gathering of financial analysts earlier this week, his company isn't interested in a unit shipment battle with Acer. Acer boosted its position largely by selling netbooks, the popular, no-frills and tiny laptops aimed primarily at providing Internet access.

"We're focused on profit-share, not market-share," Dell said, according to the Bloomberg report.

Amen to that.

Berk

Disclosure:  Long DELL for our clients' accounts. 

Universal Car Care

Nature, not humans, likely responsible for recent global warming

I understand that many believe that humans and especially those American humans have caused the Earth to gow red hot.  I am willing to listen and understand the science and probability that 1) the Earth is warming 2) that humans are the culprit and 3) we can collectively do something about it at a reasonable cost.  But we keep getting evidence to the contrary:

Our paper confirms what many scientists already know: which is that no scientific justification exists for emissions regulation, and that, irrespective of the severity of the cuts proposed, ETS (Australian Emissions Trading Scheme like our Cap n Trade bill) will exert no measurable effect on future climate. - R .M. Carter, Co-Author of Marine Geophysical Laboratory, James Cook University, Townsville, Queensland, Australia

There are many "justifications" for curbing carbon emissions but the one used by the proponents of Cap n Trade in the U.S. and other emission trading schemes around the world - that carbon emissions cause global warming which will destroy the planet "soon" is not one of them.  And it is not because it is not true - it may be, but science is never settled as the Al Gore's of the world lead us to believe.  Scientific knowledge is based on probabilities not certainty and lately the probability that global warming is manmade and we can do something about it is getting smaller.  Of course, that does not mean we should not get off of carbon fuels.  But it does mean that growth reducing initiatives like Cap n Trade are a messy and unnecessary cost imposed on the economy.  The "fear' and "misinformation" used to sell such a scheme could very well backfire as the public feels that they were duped and will not support any regimen to transition to alternative energy use.

Unfortunately, it seems to me that there are many many more pressing problems in the world that we can actually change for the better at an acceptable cost. And more and more it looks like global warming ain't one of them.

I doubt that "true believers" will be moved by the newest peer-reviewed evidence (notice I would never say proof because the only certainty is contained in the mind through "faith" as in religion, not as in science) from Chris de Freitas, John McLean and Bob Carter, scientists at universities in Australia and New Zealand. They write in the Journal of Geophysical Research:

The surge in global temperatures since 1977 can be attributed to a 1976 climate shift in the Pacific Ocean that made warming El Nino conditions more likely than they were over the previous 30 years and cooling La Nina conditions less likely" says co-author de Freitas.

We have shown that internal global climate-system variability accounts for at least 80% of the observed global climate variation over the past half-century. It may even be more if the period of influence of major volcanoes can be more clearly identified and the corresponding data excluded from the analysis."

An Investor's Business Daily editorial explains the significance:

IBDeditorials.com: Editorials, Political Cartoons, and Polls from Investor's Business Daily -- Ignoring Science.

These findings are largely being ignored by the mainstream media. They simply don't fit the worn narrative that man is dangerously warming the Earth through his carbon dioxide emissions and a radical alteration of Western lifestyles mandated by government policy is desperately needed.

They will be ignored, as well, by the Democratic machine that is trying to ram an economy-smothering carbon cap-and-trade regime through Congress.

Despite efforts to keep the global warming scare alive, the growing evidence that humans aren't heating the planet is piercing the public consciousness and alarmists are becoming marginalized.

Sharp Americans are starting to understand H.L. Mencken's observation that "The urge to save humanity is always a false front for the urge to rule it." That pretty much sums up the modern environmentalist movement.

If the Waxman Markey cap and trade regime is really about saving the planet or weening the US off of foreign oil, Congress should have the courage to start over and impose a straight tax on carbon fuel consumption that is scarce in the U.S.  And it should not discourage but encourage the search for oil and natural gas in the United States - tax the consumption if they must - but this creation of carbon credits and trading allowances is more about control and power than it is about good policy.

In the end it will fail miserably because the false premise on which it has been sold - American humans are especially guilty of burnig the planet and causing disasters beyond belief.  That is "probably" not true - and as the public learns more about its leaders' propaganda the less likely it will accept their radical prescriptions for relief.

Berk

Citation:McLean, J. D., C. R. de Freitas, and R. M. Carter (2009), Influence of the Southern Oscillation on tropospheric temperature, J. Geophys. Res., 114, D14104, doi:10.1029/2008JD011637.

Polls Down;Stock Market Up

I have been doing some work on the measurement problem in politics - specifically how those "damn statistics" are tortured until they support some broad policy initiative.

The Democrats and President Obama in particular have hammered home the unfairness of the "Bush Tax Cuts" because income inequality has grown so wide. The rich are getting all the favors from the rich that were in power is the story that is told.

This purported fact alone is repeatedly cited without even a peep from the media, the other side or citizens.  The problem is that "income inequality" is meaningless without context and certainly by itself does not call for a more "progressive" - soak the rich - tax policy. 

During the campaign the President famously suggested to Joe-the-Plumber that we need to spread the wealth around. 

I will show in a later post that this President does not give a hoot about economic growth, only about redistribution in the name of social justice. How do we measure "well being" and are the income growth statistics really so flat for the Middle Class?  And does economic inequality really translate automatically into social and politcal injustice?  Do the rich dominate politcs and make policy to cement their hold on power? 

It seems that the election of the President and a Democratic Congress with a filibuster proof majority would suggest that the rich do not always gravitate toward the party that taxes them less.  In fact, there were many more wealthy Americans trying to elect this President who made no bones about his objective was to tax the rich more and redistribute their property/income to the less rich and poor.

What's going on here?  Perhaps we do not have an entrenched plutocracy like Paul Krugman of Princeton and the NY Times predicts; maybe we have a government by the idle elites who feel entitled to experiment with grand policies that will entrench their power.

My point today, though, is to remind my readers that this basic mistake about how well off the Middle Class is and how it has fared under "Free Market Economics" has policy and budgetary implications which in turn have growth implications. 

The stock market knows this - as it always does.  It is not a coincidence that at the same time that the President's personal poll numbers are moving lower -below Carter's now at this time - that the stock market has moved way up off its bottom.  The NASDAQ just turned in its best performance in terms of the number of winning sessions in a row since 1992. 

USA Today said this today:

A president's standing after his first six months in office doesn't forecast whether he'll have a successful four-year term, but it does signal how much political juice he'll have for his second six months in office.

The stock market wants less juice and more growth, thank you.

Polls can affect president's hold on party - USATODAY.com.

BERK

Bear turns to Bull?

Our Trend indicators on the S&P 500 Index all flashed green yesterday and the market promptly rallied big time today.  No sooner than all indices made ytd highs - Microsoft disappoints after the close.  And that's a good thing.  We will be able to put our remaining cash in the market on the "break" which will simply be a pause to refresh.

dshort.com: Bull Market or Bear-Market Rally?.

BERK