Archive for January, 2011

Plans being drawn up to let states declare bankruptcy

Saturday, January 22nd, 2011

Scarily interesting article from the New York Times that could impact a whole lot of people in our community :

The New York Times

updated 1/21/2011 7:39:56 AM ET 2011-01-21T12:39:56

Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care.

Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides.

Bankruptcy could permit a state to alter its contractual promises to retirees, which are often protected by state constitutions, and it could provide an alternative to a no-strings bailout.

Along with retirees, however, investors in a state’s bonds could suffer, possibly ending up at the back of the line as unsecured creditors.

“All of a sudden, there’s a whole new risk factor,” said Paul S. Maco, a partner at the firm Vinson & Elkins who was head of the Securities and Exchange Commission’s Office of Municipal Securities during the Clinton administration.

For now, the fear of destabilizing the municipal bond market with the words “state bankruptcy” has proponents in Congress going about their work on tiptoe.

No draft bill yet
No draft bill is in circulation yet, and no member of Congress has come forward as a sponsor, although Senator John Cornyn, a Texas Republican, asked the Federal Reserve chairman, Ben S. Bernanke, about the possibility in a hearing this month.

House Republicans, and Senators from both parties, have taken an interest in the issue, with nudging from bankruptcy lawyers and a former House speaker, Newt Gingrich, who could be a Republican presidential candidate.

It would be difficult to get a bill through Congress, not only because of the constitutional questions and the complexities of bankruptcy law, but also because of fears that even talk of such a law could make the states’ problems worse.

Lawmakers might decide to stop short of a full-blown bankruptcy proposal and establish instead some sort of oversight panel for distressed states, akin to the Municipal Assistance Corporation, which helped New York City during its fiscal crisis of 1975.

Still, discussions about something as far-reaching as bankruptcy could give governors and others more leverage in bargaining with unionized public workers.

“They are readying a massive assault on us,” said Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees. “We’re taking this very seriously.”

Mr. Loveless said he was meeting with potential allies on Capitol Hill, making the point that certain states might indeed have financial problems, but public employees and their benefits were not the cause.

The Center on Budget and Policy Priorities released a report on Thursday warning against a tendency to confuse the states’ immediate budget gaps with their long-term structural deficits.

“States have adequate tools and means to meet their obligations,” the report stated.

No state is known to want to declare bankruptcy, and some question the wisdom of offering them the ability to do so now, given the jitters in the normally staid municipal bond market.

Slightly more than $25 billion has flowed out of mutual funds that invest in muni bonds in the last two months, according to the Investment Company Institute.

Many analysts say they consider a bond default by any state extremely unlikely, but they also say that when politicians take an interest in the bond market, surprises are apt to follow.

Mr. Maco said the mere introduction of a state bankruptcy bill could lead to “some kind of market penalty,” even if it never passed. That “penalty” might be higher borrowing costs for a state and downward pressure on the value of its bonds. Individual bondholders would not realize any losses unless they sold.

Last-minute plea for cash?
But institutional investors in municipal bonds, like insurance companies, are required to keep certain levels of capital. And they might retreat from additional investments. A deeply troubled state could eventually be priced out of the capital markets.

“The precipitating event at G.M. was they were out of cash and had no ability to raise the capital they needed,” said Harry J. Wilson, the lone Republican on President Obama’s special auto task force, which led G.M. and Chrysler through an unusual restructuring in bankruptcy, financed by the federal government.

Mr. Wilson, who ran an unsuccessful campaign for New York State comptroller last year, has said he believes that New York and some other states need some type of a financial restructuring.

He noted that G.M. was salvaged only through an administration-led effort that Congress initially resisted, with legislators voting against financial assistance to G.M. in late 2008.

“Now Congress is much more conservative,” he said. “A state shows up and wants cash, Congress says no, and it will probably be at the last minute and it’s a real problem. That’s what I’m concerned about.”

Discussion of a new bankruptcy option for the states appears to have taken off in November, after Mr. Gingrich gave a speech about the country’s big challenges, including government debt and an uncompetitive labor market.

“We just have to be honest and clear about this, and I also hope the House Republicans are going to move a bill in the first month or so of their tenure to create a venue for state bankruptcy,” he said.

A few weeks later, David A. Skeel, a law professor at the University of Pennsylvania, published an article, “Give States a Way to Go Bankrupt,” in The Weekly Standard. It said thorny constitutional questions were “easily addressed” by making sure states could not be forced into bankruptcy or that federal judges could usurp states’ lawmaking powers.

“I have never had anything I’ve written get as much attention as that piece,” said Mr. Skeel, who said he had since been contacted by Republicans and Democrats whom he declined to name.

Fear of bankruptcy ‘panic’

Mr. Skeel said it was possible to envision how bankruptcy for states might work by looking at the existing law for local governments. Called Chapter 9, it gives distressed municipalities a period of debt-collection relief, which they can use to restructure their obligations with the help of a bankruptcy judge.

Unfunded pensions become unsecured debts in municipal bankruptcy and may be reduced. And the law makes it easier for a bankrupt city to tear up its labor contracts than for a bankrupt company, said James E. Spiotto, head of the bankruptcy practice at Chapman & Cutler in Chicago.

The biggest surprise may await the holders of a state’s general obligation bonds. Though widely considered the strongest credit of any government, they can be treated as unsecured credits, subject to reduction, under Chapter 9.

Mr. Spiotto said he thought bankruptcy court was not a good avenue for troubled states, and he has designed an alternative called the Public Pension Funding Authority. It would have mandatory jurisdiction over states that failed to provide sufficient funding to their workers’ pensions or that were diverting money from essential public services.

“I’ve talked to some people from Congress, and I’m going to talk to some more,” he said. “This effort to talk about Chapter 9, I’m worried about it. I don’t want the states to have to pay higher borrowing costs because of a panic that they might go bankrupt. I don’t think it’s the right thing at all. But it’s the beginning of a dialog.”

2010 Performance Comparison

Thursday, January 20th, 2011

I get questions from clients and others about how our investment performance compares to others. I think we do a pretty fine job, but I thought it might be interesting to do a comparison.

Below, I have listed a selection of the large Hedge Funds that are prominently talked about on TV, particularly on CNBC. These are very respected investment managers with billions of dollars under management.

The source for these Hedge Fund 2010 returns is marketfolly.

BankChampaign Equity Management: +22.62%

Paulson & Co Advantage Fund: +11%.

Paulson & Co Advantage Plus Fund: +17%

RenTec’s RIFF: +22.7%

RenTec’s RIEF: +16.5%

Millennium Management: +13.3%. Israel

Greenlight Capital: +12.5%.

SAC Capital: +15%.

Pershing Square Capital: +29.7%

Tudor Investment Corp: +7.5%.

Glenview Capital: +15.3% net..

Moore Capital: +3%.

AQR Capital: +27.3%.

JANA Partners: +8.4%.

Clarium Capital: -23%.

Citadel Investment Group: +10%.

Passport Capital: +18.3%.

Centaurus Energy: -3.8%.

Xerion Fund (Perella Weinberg Partners): +12.66%.

BlueCrest Capital: +16%.

T2 Partners: +10.3% net.

Och-Ziff: +8.44

Perry Capital: +14.6%.

This is not an apples to apples comparison, clearly, as we use a long-only equity management style and these are hedge funds that can use long and short positions as well as concentrations in various asset types. And many of these managers have a history of performance that is significantly above the returns shown above. However, it does show that our process provides extremely competitive returns for our clients.

You have my apology if this seems like its bragging, and maybe it is to a certain extent, but I do get asked how we compare so I thought I’d share.


Market Changes Character

Thursday, January 20th, 2011


Yesterday was one of those days when all asset classes had problems: stocks, commodities, gold, you name it. It was a classic “Risk Off” trade and contrary to recent Risk Off trades, the dollar fell in concert.

I thought you all might like to see the technical graph I follow that helps me get a feel for the direction of the market.

In the graph above, I have noted a few things with annotations that are important to follow. You can see that in the top section (the RSI indicator), we were in a severe overbought state based upon Relative Strength. Anytime the market exceeds the 70 level, we are in overbought territory and those situations either rectify themselves with the passing of time or a fall in prices. Yesterday we had the first 1% pullback since November.

In the middle section (the Summation Index) I’ve drawn a few circles around some crossovers in the indicator and its moving average. You can see that whenever the black line crosses the pink line we have a movement from overbought or oversold status on the RSI – in the case of the pink circles we have a price adjustment in the market – in the case of the blue circle, we have a passing of time. I thought you might find it interesting to see how overbought situations adjust themselves in both scenarios – particularly since the black line crossed the pink line today.

The other important thing to see in the middle section is the relationship of the black line to its history. You can see that it has not approached the November peak in the indicator, which shows that the current trend coming out of the November sideways market was less intense than the previous trend. This middle section represents the intermediate trend of the market.

The important thing to see in the bottom section (the McClellan Oscillator) is that we had a near-term trend that was weakening and has turned negative, dropping below the zero line.

Given that we have a steady stream of money coming into the market based upon the liquidity stream coming out of the Federal Reserve, I’d anticipate that the current weakness will be limited and will provide an opportunity for buyers to step in at lower prices than on Tuesday.

The current situation with the Federal Reserve’s Quantitative Easing program is unprecedented in terms of how it will impact our market – but if we look at Japan Nikkei, they have a long rally in their index as long as their program was in operation. I expect that we will follow that model, but we will continue to watch our indicators to give us a feel for where the market is headed – and share that with you here on the blog.

In honor of the recent midnight tax increase in Illinois that wasn’t accompanied by any serious consideration of spending cuts, I thought the following video from the recently deceased Gerry Rafferty might be appropriate (a friend pointed out that in the photo of the swearing in of the current batch of legislators there were roughly $3,000 of roses in vases – the day after the tax increase – amazing, really):

Click Here to Watch the video on You Tube


2011: A Debt Odyssey

Monday, January 10th, 2011

Below is the year-end newsletter that I send to clients. Some of you reading this will receive it directly, others of you will not, so I thought I’d share it here on the blog.

As we leave 2010 and look forward to 2011, there are a few macro events that will likely guide successful investing in the year ahead. Our growing national debt, I believe, will be the overarching issue that all other issues either contribute to or are impacted by.

At a recently hit new high of $14 Trillion, our national debt is so massive that it defies comprehension.

First, the number itself is mind-blowing to me: $14,000,000,000,000. Just seeing it in print with all of those zeroes makes my eyes cross.

Second, if you look at it in terms of distance, you can think of it this way: if you laid one dollar bills end-to-end it would make a line that stretches from the Earth to the Moon, not just once, not just ten times, not even 100 times, but 5,600 times. Remember those news clips of the Apollo astronauts that went to the Moon? Can you imagine them traveling there on 5,600 separate trips?

Third, if you think of it in terms of time, it looks like this: if you earned $1 every second, it would take you 448,000 years to earn $14 Trillion. Time is money, as they say.

The associated issues that come along with the increasing national debt – currently forecast to hit $20 Trillion in the next few years – are: (1) Likely rising interest rates as the purchasers of our debt require higher returns to continue loaning us money; (2) Likely government budget cuts to defense and social programs; (3) Likely tax increases; (4) Likely continuation of our Federal Reserve’s Quantitative Easing program; (5) Likely increase in inflation beyond the price increases in food, energy, and other commodities that we are already seeing; (6) Likely slow economic growth; and (6) Likely a sustained high level of unemployment.

In spite of our growing levels of national debt, as long as the Federal Reserve continues to provide liquidity to our economy through low interest rates and the Quantitative Easing program, we should see our stock and commodity markets perform pretty well. However, if the Federal Reserve provides any indication that they are going to stop the Quantitative Easing program, if they announce an intention to raise short-term interest rates, or if they say that they see any sign of inflation moving beyond food, energy, and other commodities, we will have a correction.

The correction, if it comes due to one of those factors, will be a knee jerk reaction by the short-term traders, the momentum investors, and the quants (the mutual funds and hedge funds that buy and sell based solely on movements in price – no fundamentals involved in their decision process). The rubber will hit the road after that as investment returns will be based solely on the prospect for corporate earnings and the impact to investor sentiment from the perceived direction of the overall economy. But, we are not there yet. As long as the Federal Reserve maintains its current policy, stocks and commodities – as well as short-duration, inflation protected, and adjustable rate bonds – are the safest place to keep your investment portfolio other than certificates of deposit.

So, let’s look at what we might see in 2011…

US Stock Market

Analyst estimates for 2011 earnings on the S&P 500 are $92 per share, up from $82 in 2010. That is growth of just over 12%. However, throughout 2010, companies were far more likely to exceed estimates than fall short of them. The ratio was better than 4 to 1 in each of the four quarters according to Zacks Investment Research.

Since the end of the third quarter, more analysts have been raising estimates than cutting them. It is possible that 2011 earnings will be above $92 and this will drive stock prices higher.

If we assume (and its always a big assumption) that the current P/E ratio of 15 for the market will stay in place, then $92 gives us a target level of 1,380 for the S&P 500 in 2011 or about a 9% increase in stock prices above current levels.

If analysts are wrong and corporate earnings are greater than $92, then the S&P 500 could be higher than that in 2011. If earnings are $97, and P/E ratios remain the same, we could see a target level of 1,455 for the S&P 500 in 2011, or about a 14% increase in stock prices above current levels. This is not a prediction, but just food for thought.

If the Federal Reserve ends its liquidity program or if investor sentiment turns negative, then the 15 P/E ratio could be lower. As a downside, if corporate earnings come in at $87 and the P/E ratio contracts to 12 we could see a downside target 1,044, or 17% downside – that isn’t a prediction, but rather to give you some perspective on what we could see if the current situation changes for the worse. It’s not the end of the world but rather takes us back to where we started 2010.

As we move into the third year of President Obama’s term, particularly with a change in the control of the House of Representatives, it is interesting to look back in history to see what occurred. The news is good: (1) according to the Stock Traders’ Almanac, the third year of a presidential cycle is almost always the strongest of the four and shows a positive return; and (2) historically, the political combination of a Democrat in the White House and a GOP controlled Congress has been the best of the four possible combinations for governing the country in terms of stock prices (remember the positive stock markets of the Clinton/Gingrich years?)

Foreign Stock Markets

The world economy should be pretty strong in 2011, particularly in the developing world.

Asia will continue to grow at high single digit or low double digit GDP growth rates. The exception to that will be China as it tries to slow its economy in an effort to fight inflation of the food, energy and other commodity variety. Our focus in the emerging markets is on the non-China Asian markets of Singapore, South Korea, Vietnam, Taiwan, Indonesia and Malaysia, all of which should show strong economic growth as they benefit from demographic shifts that move much of Asia from subsistence living to middle class lifestyles. The same can be said for Latin American and Eastern European economies in our focus: Chile, Brazil, Argentina, Columbia, Panama and Poland.

The higher GDP growth rates and negligible levels of debt in these economies should provide investors with a reason to give the companies deriving earnings in those countries a premium valuation. This includes both companies domiciled in those countries as well as US companies that make significant sales to those countries.


As has been our focus for a number of years, the resources that are in limited supply but growing demand – and the companies that produce them – represent some of the best investment possibilities in the year ahead. With the demographic shifts in Asia and Latin America come increased demand for raw materials, energy and agricultural products. This will ultimately lead to increased earnings for the producers and increased value for the raw materials they are producing.

The growing earnings and increased value of the raw materials should continue to propel the stock prices for commodity companies higher in 2011, outpacing the broader S&P 500.

Fixed Income Investments

Fixed income will be a difficult asset class in 2011. We have already seen bond yields begin to rise as investors start to worry that the current Federal Reserve policy will bring about rising inflation, and with it, increased interest rates. No one wants to lock in 4% for 20 years if you can lock in 5% next year or 6% the year after that. The consequence of this is this mindset is that bond yields rise and the market value of bonds falls.

In order to combat this, we have been reducing durations in bond portfolios for several months and shifting to a combination of short-duration bonds, inflation protection bonds, and adjustable rate bonds. Clients should see these changes in their portfolios when they review their statements.

The Dollar

The dollar is likely to be strong in the near-term as it is the best of the big three. The problems in Europe with the weaker economies and their serial bailouts will continue to weaken the Euro. The demographic issues in Japan along with their own national debt that is double their GDP should weaken the Yen vis-à-vis the dollar. And, if the Fed does decide to end their Quantitative Easing program or raise interest rates, the dollar should rally significantly meaning that we would lower our allocation to foreign markets until that has run its course.

In the longer term, I think the dollar will weaken against a broader basket of currencies as international trade diversifies beyond the dollar into the Yuan or some other as-yet unidentified vehicle.

2010 Investment Management Performance

Many of you who read this that are not clients always ask how our investment performance has been. We have all sorts of clients, some that want us to just manage stocks for them, some just fixed income, others that are a blend of the two. Since everyone has different objectives, the more aggressive ones have higher returns than those you see below and the more conservative ones have lower returns than you see below, but these numbers are an average of all accounts that we manage in individual stock and bond accounts:

2010 Equity Management Performance: 22.62% Vs 15.07% for the S&P 500 Index

2010 Fixed Income Management Performance: 12.37% Vs 3.98% for the Bond Index

2010 Blended Account Performance: 19.45% Vs 12.94% for Composite Index

For those of you who ask about long-term performance, since 1998 our Blended Account Performance has averaged 10.26% compared to the Composite Index of 4.45%, and that includes managing through two stock market crashes and taking advantage of their subsequent recoveries.

In Summary

So, looking forward into 2011, as long as the liquidity engine from the Federal Reserve continues to pump money into our economy, the equity and commodity markets should continue to move higher. The bond market will likely be a difficult place to make money outside of the areas noted above, and the foreign markets may, for a period of time, be a smaller allocation within client portfolios than currently allocated.

We are in the process of performing a comprehensive review of our entire equity management program. We are looking at the companies we own in client portfolios in terms of what worked in the 1970’s. What we have found is that despite rising interest rates, high unemployment, and economic malaise, companies that were able to increase efficiencies – either within their own operations, through the products they produce, within the services they sell to other companies, or in the production of energy and other means of output – were able to increase their earnings and stock prices greater than the broader market. In light of this, we will be repositioning accounts to focus on companies that fall within this efficiency concept in order to continue to provide returns that are better than the broader market and our competitors.

As I write on our blog, invest what you see not what you believe. I believe the national debt will be a big problem if we don’t address it – and soon. However, what I see are rising corporate earnings and increasing stock and commodity prices as well as opportunities to beat the broader market by focusing on efficient companies – so that is how we intend to invest until we see something different.

If you would like to stay current on our investment management activities in terms of where we see the market moving and what we are doing with client portfolios, you can find that by visiting our blog at:

If you are already one of our clients, we sincerely thank you for your business and look forward to working with you in the years to come. If you are not currently a client and you would like to discuss how we can manage your investments, please give us a call at (217) 351-2870 and ask for John Clausen, Charlie Osborne, or Mark Ballard.

Best wishes for a profitable 2011!

From Russia With Ideas

Monday, January 3rd, 2011

Red Square New Years Eve

I’m back from Moscow, this year’s New Year’s trip, and just thought I’d share some of the investment related things I learned (with apologies to Ian Flemming for the title above). This photo was taken at 2am on Jan 1st in Red Square and St. Basil’s Cathedral in the snowy New Years Eve with celebrating Moscovites and yours truly.

Most of you who know me either personally or through the blog know that travel is one of my passions as I enjoy learning about the culture, history, religion, art and architecture in foreign lands – but it serves the dual purpose of allowing me to see what is happening outside the US that might positively impact my investment management activities.

I was in Russia a few years ago and there is a noticeable change between the mood then and now. Consumerism and economic activity seem to be on a significant upward trajectory now:

> Lots of Japanese and German cars as well as a number of Fords – not to mention the Bently and Lamborghini dealerships I saw;

> McDonalds, Starbucks, and Dunkin Donuts all over the place (oddly, unlike China, no KFC);

> I was talking to the bartender at our hotel and he was saying his favorite American beer is Corona (I decided not to tell him its from Mexico) and that he thinks its a bargain at 500 rubles ($18) for a six-pack;

> Russia has decided to operate within the rules of the WTO and, as an example, they no longer sell Russian “Champagne” but instead Sparkling Wine (Champagne only comes from that specific region in France);

> The GUM mall that sells designer clothes was packed with shoppers;

> The big news there was that President Medvedev was reducing the size of the government by 20% in an effort to improve the solidity of the country’s finances;

> Public safety seems to be on the rise – police and the military were very visible with Tom Ridge level scrutiny using metal detectors and pat downs for entrance into public buildings – but the security people were in general very friendly and courteous (unlike those at O’Hare and Dulles on this trip).

On the downside, you still can see some level of chaos of the third world, specifically with the problems at the airport during the recent ice storm, the problems with the legal system and justice as exemplified by the piling on of additional charges for the former head of an oil company to keep him in jail as he nears the end of his original sentence and the jailing of opposition politicians while I was there, the steady influx of Central Asian immigrants that are taxing the social welfare system, and the evolving accounting standards that have not-yet reached Western level.

All-in-all, you can see a very visible change that should continue to drive their economic activity and stock prices higher in coming years, particularly with near-$100 oil to drive cash into the economy.

In coming weeks, we will be reviewing investment opportunities into this growing Russian economy – we will look at Russian companies that have ADR’s traded in the US plus domestic companies that derive earnings from sales to Russia. Clients should begin to see these ideas come into play in their accounts as ideas are identified and entry points chosen.

Until then, if you are bored and want to see a bit more of Moscow in the Winter, you can check out my travel website at:

Click on this link to go to the travel website. Once you are redirected to that website, just click on the Moscow gallery link and it will take you to the set of photos.