CB Capital Research, Inc.

The New 21st Century Capitalism: The Curious Case of Veronica Mars

April 28, 2013 By cbcapitalresearch

The class struggle between the bourgeois capitalist and the proletariat—classified by Karl Marx as two distinct but interdependent social classes—is arguably Capitalism’s most famous “internal contradiction.” Marx argued 150 years ago that the constant competition for “surplus value” (whose definition is based on Marx’s misguided “Labor Theory of Value”) between capitalists and workers would result in ever-larger cycles and crises—ultimately bringing about the demise of the capitalist system.

Along with the constantly diminishing number of the magnates of capital, who usurp and monopolize all advantages of this process of transformation, grows the mass of misery, oppression, slavery, degradation, exploitation; but with this too grows the revolt of the working-class, a class always increasing in numbers, and disciplined, united, organized by the very mechanism of the process of capitalist production itself … Centralization of the means of production and socialization of labour at last reach a point where they become incompatible with their capitalist integument. This integument bursts asunder. The knell of capitalist private property sounds. The expropriators are expropriated.

Karl Marx gave a fine gift to those seeking only to dissect and disprove his arguments, and better understand the essence of capitalism. Political leaders who adopted Marxist thought in any practical manner would destroy their own countries and the lives of millions of people (Hugo Chavez also gave us a fine gift: the basket case that is Venezuela, despite $100 oil, provides ready ammunition for any dinner debate on the virtues of capitalism). In fact, Joseph Schumpeter would devote over 50 pages to discrediting Marxian thought in his seminal work “Capitalism, Socialism and Democracy.”

Counter-arguments to silly notions such as the Labor Theory of Value, distinct social classes such as the bourgeois capitalist and the proletariat, the proletariats’ overrated organizational skills, and the inevitable result of revolution are common everywhere in the 21^st century global economy. The quintessential example is Apple’s iPhone (Disclosure: I went long AAPL at $401.07 on April 23^rd). The iPhone’s design—along with the organizational/marketing skills required to manufacture/sell such a product on a global scale—reigns supreme. Virtually all the “surplus value” accrue to the design, marketing, and organizational team at Apple—and rightly so—while the Chinese manufacturers and their laborers accrue little, if any. Furthermore, the sense of high drama required for any revolution—one sufficient to overthrow the bourgeois—is missing. The poetic sense of Revolution as conveyed by the likes of Thomas Jefferson and James Madison is simply not attractive in a society where the Forbes 400 list turns over once every 20 years, and where kids of all ages are addicted to video games. Capitalism, over time, naturally overthrows each and every bourgeois capitalist through the process of “creative destruction” and the lack of hereditary titles. In addition, the PC and internet revolutions—accompanied by the rise of global networks/corporations such as Amazon, eBay, and Google—have allowed all those that dare to become a capitalist and entrepreneur. In fact, recent trends suggest that the global capitalist/entrepreneurial spirit is growing stronger than ever. For example, employee compensation as a percentage of U.S. GDP has declined to a new 58-year low (as shown on the following chart). Yes, U.S. corporations and businesses are squeezing more out of its workers, even as economic growth recovers. At the same time, this also suggests that more Americans are becoming entrepreneurs and starting their own businesses.

With the further advent of automation, 3-D printing, and globalization (including the democratization of education, communications, and labor mobility), U.S. labor will continue to be squeezed in the long run. Consider this: I know folks being paid six-figures by pressing buttons to optimize an investment portfolio and to make/reconcile trades. They have little understanding behind the quantitative investment/optimization process; and certainly cannot replicate or design a new system on their own. These folks are what Ayn Rand would call “the second-handers” who are simply feeding off the scraps of the creative class—and thus do not deserve six-figures. The market will recognize this over time.

Make no mistake: The capitalists will continue to rise and become ever more important as the 21^st century progresses. French economist Charles Gave (of GaveKal) coined the term “Platform Company” to describe high ROC companies focused on design, marketing, and organization, while spinning off their manufacturing responsibilities (again, the quintessential example is Apple Computer). Of course, such a business model only works in a world that abides by the rules of free trade. In the first decade of the 21^st century, the platform company model was the Holy Grail for capitalists: Design and market; outsource manufacturing and produce everywhere. A platform company’s capital (the denominator in “ROC”) is mainly the people it hires. In most cases, the company did not have to invest in such capital; their parents and alma maters did most of the work. The success of the platform company model is exemplified by Apple’s extremely high margins (making up just 2.0% of total S&P 500’s sales; but 5.6% of all profits), along with its high growth rates in recent years (following table courtesy Goldman Sachs).

In the second decade of the 21^st century, the platform company model itself is being turned on its head. The first inkling came with the creation of Wikipedia in 2001—giving volunteers from all over the world to create value and compete with private interests through mass collaboration. Termed “Wikinomics,” this trend of creating value through mass voluntary collaboration would result in efforts such as the Amazon Review System, the YouTube video sharing platform, and social networking. Corporations would seek to monetize the value of such mass voluntary collaboration. As long as the volunteers are happy (many of them are—either because they are only seeking to find their voice, or an audience for their future work), companies like Amazon, eBay, and Facebook could keep their competitive advantages by maintaining their strong network effects. The ROC of such business models is extremely high—as unlike say, Apple, YouTube has no need to pay salaries to content creators.

In other words, Marx’s prediction that—one day—the proletariat will overthrow the bourgeois capitalist has been turned on its head. Far from overthrowing the capitalists, the proletariat (I use this term very loosely) is happy to contribute to the capitalists’ success on a voluntary basis. Writing an Amazon review or producing a YouTube video is far from the backbreaking work of the 19^th century; more important, such activities allows each of us to express our individuality—or as a first step to monetize our creativity. The success of the platform company and the Wikinomics models is now leading into something else—which I call the “Veronica Mars” model. The Veronica Mars Movie Project was the first Kickstarter effort to revive a cult classic through its fan base. To the surprise of many (including its creator Rob Thomas, and the franchise owner, Warner Brothers), the Kickstarter effort reached its fund-raising goal of $2 million in less than 10 hours. By the end of the 30-day fund-raising period, it has raised over $5.7 million through 91,000 fans. The Veronica Mars Movie Project set a precedent (good or bad—you decide); and subsequently actor/director Zach Braff has jumped on the Kickstarter bandwagon. His project “Wish I Was Here” reached his fund-raising goal of $2 million after only three days.

Yes, both the movie studios and the creators have spent enormous amounts of capital on such franchises. Nevertheless, on a stand-alone basis, the ROCs (which mostly accrue to Warner Brothers and other publicly owned studios) of these fan-funded projects are literally infinity. So yes, Mr. Byron Wein, while there are practical limits, the ROCs of U.S. corporations can continue to rise. Capitalists—through strong creative, marketing, organizational, and outreach efforts to customers/fans—can now have our cake and eat it too. Business school textbooks and HBS cases alike are being revised as we speak. To paraphrase former President Richard Nixon (with a slight twist)—like it or not—we are all capitalists now. Either become one; or die.

Filed Under: Economics, Outlook, Productivity, Technology

Behind the Panic Selling in Gold

April 15, 2013 By cbcapitalresearch

In our January newsletter (please contact us for a copy), we argued that gold was in a major correction phase, and that over the next 12 to 18 months, gold will correct to the $1,100 to $1,300 range. Over the last five days, June gold has hit an air-pocket–declining by over $200 an ounce to trade at just over $1,350 an ounce.

Speculators in gold tend to overuse the term “money printing,” and why “money printing” will inevitably lead to higher gold prices. This is a patently false and misleading idea. First of all, global central banks (through the high-powered monetary base), commercial banks (through the traditional money multiplier), and investment banks (through balance sheet expansion and esoteric product creation) have essentially been “printing money” since the United States left the (quasi) Gold Standard for the final time in 1971. The price of gold made a major peak at $850 an ounce in January 1980. For the next 20 years, the price of gold fluctuated between $250 and $500 an ounce–despite an increase in the nominal global GDP from $18.8 trillion in 1980 to $41.0 trillion in 2000. In fact, if one was to draw a regression line from 1981 (excluding the 1980 peak) to 2000, the long-term trend in the price of gold would have been depicted as a downward sloping line! Clearly, the price of gold suggested no correlation to the amount of “money printing”–and was certainly no inflation hedge.

Second of all, our turning bullish on gold in late 2000 rested on a couple of simple ideas: 1) The last seller had left the gold market. Gold bugs were capitulating. Central banks were selling en masse, while gold producers further reinforced the downtrend by hedging (i.e. shorting) a substantial portion of their future production. Everyone I spoke to in late 2000 thought I was crazy for buying gold coins and precious metals mining stocks. Treating it as the perfect contrarian indicator, I bought more; 2) The Greenspan-led Fed would ease monetary policy in an unprecedented way. More important, we believed the excess liquidity would directly fuel commodity price inflation as the United States has dis-invested in natural resource production (including energy production) since the early 1980s oil bust. It is not a coincidence that the price of Henry Hub natural gas rose above double-digits for the first time in late 2000.

That is, we bought gold because it was: 1) the most unloved asset class, and 2) we believed the excess liquidity created by the Greenspan-led Fed would flow to this asset class. We also made a bet that investors’ perception would shift from hating gold to beginning to treat the precious metal as an alternative currency. Gold has been treated as money in most societies for the last 5,000 years, but other commodities had once been in the same coveted category, including tobacco, sea shells, tulip bulbs, copper, large stones, alcohol, and cannabis. As we argued in our January newsletter, there are few iron-clad rules, if any, when it comes to economics or the financial markets. Yes, gold had been the predominant medium of exchange for centuries. But Classical (Newtonian) Physics was in the same category, and that eventually gave way to General Relativity and Quantum Mechanics in the early 1900s. In a capitalist society, the trick is to gradually and consistently inflate, and to broadcast one’s intention/plan to inflate to economic agents well in advance. For the last several years, investors have piled onto the long side of gold because of its increasing perception as an alternative currency. Over the last five days, this perception has shifted. This shift in perception caught a substantial amount of long investors on the wrong side and by surprise. That is all.

We will leave you with one final comment: So little is understood of the implications of the BOJ easing. It is no surprise that BOJ easing has done little for gold. The purpose of the BOJ easing was to meet its 2% inflation goal through importing inflation from the rest of the world. This has been partly achieved through a devaluation of the Yen. By definition, Japan is thus exporting deflation, especially to countries such as the United States, Germany, China, and South Korea (i.e. countries that either compete directly with Japanese exports or consume Japanese goods). Deflationary pressures in the United States, Germany, China, and South Korea would only put further downward pressure on the price of gold, to the extent these countries (especially China) purchase gold as an investment or inflation hedge. Such deflationary pressures would only be offset if Japanese investors–spooked by higher inflation expectations–decide to purchase gold as a hedge. Unfortunately for gold bulls, neither Japanese investors nor consumers are significant purchasers of gold. In fact, the Japanese only made a net purchase of $394 million of gold in 2012, equivalent to just 0.9% of Chinese net purchases and 0.8% of Indian net purchases (see below table). Preliminary data also suggests that Japanese investors are more interested in purchasing the Nikkei, U.S. Treasuries and Ginnie Mae securities, German bunds, and Japanese and U.S. real estate in light of BOJ easing. I anticipate a bounce in gold prices as soon as tomorrow, but long-term gold bulls would need to wait a little while longer.

Filed Under: Gold

The Bank of Japan Surprises: Profound Implications for Global Risk Assets

April 3, 2013 By cbcapitalresearch

Since the Japanese stock market and real estate bubbles popped in 1990, one of the surest ways for a portfolio manager to get fired is to go long Japanese stocks or real estate. ROEs on Japanese companies are among the lowest in the world; while Japanese real estate prices had been mired by a 23-year secular decline. There were massive policy failures–including building “bridges to nowhere” and the infamous consumption tax hike from 3% to 5% in 1997–just as SE Asia sank into a depression. While Japan’s policy rate was eventually brought down to zero, it came too little, too late. High-ranking BOJ officials eventually stopped attending the annual Jackson Hole Economic Policy Symposiums simply because they did not want to be ridiculed by other central bankers.

All this changed tonight. The Bank of Japan just announced it will double its monetary base over the next two years, as well as embark on a massive quantitative easing policy with an annual goal of 50 trillion Yen (US$538 billion) in JGB purchases. Consensus going into the meeting was in the order of an annual 15 to 20 trillion Yen in JGB purchases. A US$538 billion QE policy is massive, as Japan’s economy is less than 40% the size of the U.S. economy. Essentially, the BOJ will be purchasing JGBs at the rate of over 9% of its GDP every year. An equivalent QE policy in the U.S. would be in the realm of nearly US$1.4 trillion in Treasury purchases on an annual basis.

The policy implications are massive. For one, no living portfolio manager had ever been surprised by the BOJ in such a manner. Surprises have been many, but those have all been disappointing. The Yen is down by 1.1% as I am writing this article. We expect more competitive currency devaluations and supressions by other Asian central banks in 2013 and 2014. Such a move will no doubt generate a massive rise in global liquidity–which will drive up the prices of risky assets around the world.

For two, we know that Japanese households have continued to hold massive amounts of cash and deposits due to ongoing deflationary fears and general aversion to risk-taking. According to the BOJ’s Flow of Funds, Japanese households held nearly 800 trillion Yen in cash and deposits as of June 2012, or nearly US$8.6 trillion (see below chart). With a yield of 0%–and with the BOJ now hell-bent on a 2% inflation target–many Japanese households will no doubt start deploying their capital back into higher-yielding or riskier assets. A mere 10% shift out of cash into riskier assets would mean a wall of liquidity totaling nearly $900 billion. Keep in mind that this amount is equivalent to the sum total of ALL U.S. equity/hybrid/bond mutual fund inflows (totaling $913 billion according to ICI) during the peak tech bubble years from 1997 to 2000! We thus expect global risk assets–especially U.S. stocks and U.S. commercial real estate–to be driven significantly higher by Japanese inflows over the next few years (to be compounded by Chinese inflows as the Chinese capital account is liberalized). All corrections from hereon should be bought.

Filed Under: Bonds, Japan, Monetary Policy, Real Estate

The Message of the CB Capital Global Diffusion Index: A Bottom in WTI Crude Oil Prices

March 17, 2013 By cbcapitalresearch

Neoclassical economics cannot explain the spike in real global wealth per capita (nearly 10x) in the 20^th century. The classic Cobb-Douglas Model attempts to explain global GDP growth through three major inputs: 1) “Total factor productivity,” 2) labor (L), and 3) capital (K). Both L and K can be quantified and explained. However, studies have shown that fully 70% to 80% of the increase in economic output during the 20^th century came from “total factor productivity,” i.e. an exogenous factor that resembles technological growth and adoption—leading to increased overall productivity. Economists have a hard time explaining the origin of “total factor productivity.” We know that education (investment in human capital), venture capital, the capitalist system, and the sharing of ideas all play a role, but we do not truly understand why their benefits were unique to the 20^th century (and to a lesser extent, the 19^th century, when real global wealth per capita grew by 3x—please request a copy of our January 2013 newsletter for a more detailed analysis).

What we do know is that the vast majority of global economic growth in the 20^th century was predicated on an exponential increase in energy consumption. In other words, productivity growth—20^th century’s main economic driver—was mostly a result of increasing energy consumption. Every technological breakthrough, such as modern-day jets, computers, fiber optics, automobiles, etc. required the consumption of increasing amounts of energy. In some areas, we have made efficiency breakthroughs (e.g. the shrinkage of CPUs), but in other areas, not so much (e.g. the internal combustion engine). Such growth is especially amazing given the mass human failures of the 20^th century, such as World War I & II, the rise of communism and Nazism, as well as the Korean and Vietnamese Wars. More important: If the 21^st century global economy is to grow in the same trajectory as that of the 20^th century, global leaders will need to find cheaper and alternative sources of energy—horizontal drilling and fracking notwithstanding.

In the meantime, global economic growth is still dependent on the consumption of fossil fuels, with crude oil being our main transportation fuel. As such, it is reasonable to conclude that—despite the increase in U.S. oil production—a rising global economy will lead to higher crude oil prices (China just surpassed the U.S. as the number one oil importer). A prediction for future oil prices thus requires an analysis of the performance of the global economy, given the globalized nature of oil. Using the Leading Indicators data for 30 major countries in the Organization for Economic Co-operation and Development (OECD), along with China, Brazil, Turkey, India, Indonesia, and Russia, we have constructed a “Global Diffusion Index” which have historically led or tracked the MSCI All-Country World Index and WTI crude oil prices since the fall of the Berlin Wall. We label it the “CB Capital Global Diffusion Index” (“CBGDI”), which is essentially an advance/decline line of the OECD leading indicators—smoothed on a three-month moving average basis. Historically, the rate of change of the CBGDI has led WTI crude oil prices by about three months, with an R-squared of 30%, while tracking or leading the MSCI All-Country World Index slightly, with an R-squared of over 40% (not surprising, since stock prices are one component of the OECD Leading Indicators). Following is a monthly chart showing the year-over-year % change in the CBGDI, and the rate of change (the 2^nd derivative) of the CBGDI, versus the year-over-year % change in the MSCI All-Country World Index and the year-over-year % change in WTI crude oil prices from March 1990 to February 2013. All four of these indicators have been smoothed on a three-month moving average basis:

As noted on the above chart, the rate of change (second derivative) in the CBGDI (red line) has historically led the YoY% change in WTI crude oil prices by about three months. The major exceptions have been 1) the relentless rise in WTI crude oil prices earlier last decade (as supply issues came to the forefront), and 2) the explosion of WTI crude oil prices during the summer of 2008, as commodity index funds became very popular and as balance sheet/funding constraints prevented producers from hedging their production. The second derivative of the CBGDI troughed at the end of 2011, and has continued to rise—implying higher global stock and energy prices. While we recognize that U.S. crude oil production is set to rise by 1.4 million bbl/day over the next two years (not a trivial amount, as 1.4 million bbl/day is equivalent to total Indonesian oil consumption), recent strength in the CBGDI suggests that WTI crude oil prices have at least bottomed, for now. More important–unless celllulosic ethanol or second-generation biofuels are commercialized in the next several years (or unless room-temperature superconductors are discovered tomorrow)–this suggests that the secular bull market in oil prices is not over.

As we are finalizing this commentary, we understand that Cyprus may be experiencing a bank run, as the EU had suggested taxing bank deposits to pay for the country’s bailout. If implemented, this will set a very bad precedent and will have long-term (adverse) repercussions in the European banking system. Such a Black Swan scenario may weaken commodity and energy prices in the short-run, but we believe WTI crude oil is a “buy” on any further price weakness.

Filed Under: Energy, Equities, Euro Zone, Outlook, Productivity

Developed Equities Overbought

February 4, 2013 By cbcapitalresearch

Since the publication of our 2013 outlook on January 7, the MSCI World has rallied by 3.7%, the MSCI EAFE by 4.1%, the Dow Industrials by 4.7%, and the S&P 500 by 3.5%. Our constructive outlook on developed equities relative to emerging markets equities was prescient, as Emerging Markets remained flat during the period. Meanwhile, Frontier Markets rallied by 5.0%. Based on our technical and sentiment indicators, both developed and U.S. equities are now overbought. For example, last week’s survey of 40 NAAIM (National Association of Active Investment Managers) member firms shows an equity exposure of 104.25%, the highest level since early 2007! This survey (courtesy Decisionpoint.com) contains data from leveraged and long-short strategies, and thus responses can vary widely. The results are then averaged every week. Inception of this poll is 2006. The latest result shows active money managers to hold a net leveraged long position, which has only occurred the second time since inception of this poll. From a contrarian standpoint, U.S. (and developed equities) are now highly overbought.

We are still constructive on developed equities, given ongoing central bank easing (the BOJ has vowed to adopt a more aggressive easing policy by actively underwriting more government spending), decent valuations, and the elimination of certain tail risks as discussed in the inaugural issue of our monthly newsletter (please email us for a sample). However, we cannot ignore the market’s overbought conditions. As such, we are revising our 12-month outlook on developed equities. Our 12-month return outlook for developed equities is revised down from a rating of 7 to 5, while our risk rating is revised from 6 to 7. Our outlook on developed equities is now on par with that for EM equities Our ratings for other major asset classes remain the same, although we are keeping a close eye on U.S. Treasuries, gold, and WTI crude oil.

Filed Under: Behavioral Finance, Equities, Outlook

CB Capital’s 2013 Price and Risk Outlook for Major Asset Classes

January 7, 2013 By cbcapitalresearch

Happy New Year. Following is our 2013 price and risk outlook for selected major asset classes. We are publishing our annual price and risk outlook for the first time, so a little explanation is required. Our rating score summarizes our view on where we believe prices will head over the next 12 months. A rating of “5″ is considered neutral–close to the asset class’ historical median return. Our risk score summarizes the probability for significant deviation from our price outlook. For example, gold’s risk score of 8 suggests the significant possibility that the asset class could remain elevated near $1,700 an ounce (as opposed to our downward forecast), as the price/demand of gold depends on many differentiated factors, such as jewelry demand in China and India; as well as a reemergence of systemic risk in peripheral Europe. The outlook on global monetary, fiscal, and global bank regulatory/lending policy is anything but certain in 2013.

More details will be provided in our CB Capital’s inaugural monthly newsletter. It will be published in the next 7 to 10 days, and will be provided to selected clients. All the best for 2013.

Filed Under: Bonds, Energy, Equities, Gold, Outlook, Real Estate

The Global Productivity Riddle and the Supercomputing Race

December 2, 2012 By cbcapitalresearch

Neoclassical (mainstream) economists define productivity as economic output (usually GDP) per unit of input, with the latter typically being capital and labor. An analysis of economic growth in the 20th century, however, suggests that physical capital per worker accounted for at most 15% of this increase. Fully 85% of productivity growth in the 20th century cannot be explained by mainstream economists.

Nobel Laureate Robert Solow was the first to propose that fully 85% of productivity growth in the 20th century was simply “a measure of our ignorance,” which he labels as technological progress. Robert Ayres, a renowned economist and physicist, asserts that the increasing consumption of energy in the 20th century explains nearly all of the productivity growth in the 20th century. We will explore this issue in a future newsletter, but not surprisingly, the future/survival of the global economy is intrinsically linked with the availability of (cheap) energy sources. With the exception of a few industries (computers, communications, healthcare) and advances over the last decade (solar PV, hybrid vehicles, carbon composites on the Boeing 787, the smart grid, etc.), productivity growth in industrial countries since the end of WWII has relied mostly on the increasing consumption of fossil fuels. While natural gas will act as a legitimate “bridge fuel” for at least the next decade, it is imperative to make ongoing investments in alternative energy technologies– as the “externalities” of burning fossil fuels remain high, especially in parts of China and other densely populated areas.

Speaking of advances in the computing industry, the world of supercomputing and supercomputing research remains an area of U.S. domination. Last month, the 40th semi-annual edition of the top 500 list of the world’s most powerful supercomputers was published at the SC2012 supercomputing conference in Salt Lake City. Last year’s biggest surprise (at least to those outside the supercomputing community) was the ascendance of the Japanese in the rankings. At the time, the number one supercomputer was the “K Computer” built by Fujitsu, using its own proprietary SPARC64 Vlllfx CPUs. Powered by 88,128 CPUs (each with eight cores, for a total 705,024 cores), the “K Computer” is capable of a peak performance of 10.51 petaflops.

Beginning this year, however, the U.S. regained the supercomputing crown, when the IBM Blue Gene-powered “Sequoia” at the Lawrence Livermore Laboratory came online with a staggering peak performance of 16.33 petaflops. The latest November 2012 list ushered in a new number one ranked supercomputer–the AMD CPU/Nvidia GPU powered monster, “Titan”–coming in at 17.59 petaflops. More important, Titan is slated for civilian use. One of its first projects is to run simulations designed to improve the efficiency of diesel and biofuel engines.

On the other hand, the Chinese, which captured the supercomputing race in October 2010 with its Tianhe-1A supercomputer at the National Supercomputing Center in Tianjin (rated at 2.57 petaflops) has now sunk to 8th place.

From a geopolitical standpoint, the United States has re-occupied the top spot after ceding to the Japanese last year, and the Chinese the year before. On a country basis, the U.S. houses 55% of the top 500 supercomputers, up from 43% just 12 months ago (by supercomputing power; note that the NSA – which houses some of the most powerful systems in the world – stopped reporting in 1998). Japan is second, with 12% of the world’s supercomputing power. Rounding out the top five are China (8%), Germany (6%), and France (5%). The UK, which ranked third just three years ago (with 5.5% of the world’s supercomputing power), is now in 6th place, housing just 4.5% of the world’s supercomputing power.

Aside from providing the most up-to-date supercomputing statistics, the semi-annual list also publishes the historical progress of global supercomputing power – as well as a reasonably accurate projection of what lies ahead. Following is a log chart summarizing the progression of the top 500 list since its inception in 1993, along with a ten-year projection:

Today, a desktop with an Intel Core i7 processor operates at about 100 gigaflops (note that we are ignoring the GPU in our graphics processor from our calculations) – or the equivalent of an “entry-level” supercomputer on the top 500 list in 2001, or the most powerful supercomputer in the world in 1993. On the highest end, the power of the Titan Supercomputer is equivalent to the combined performance of the world’s top 500 supercomputers just four years ago. Moreover,the combined performance of “Sequoia” and “Titan,” makes up more than 20% of the combined performance of all the supercomputers in the top 500 list today. By the 41st semi-annual edition of the Top 500 supercomputers next June, the combined performance of the world’s 500 fastest supercomputers should exceed 200 petaflops (compared to 162 petaflops today, and just 74 petaflops a year ago).

Simulations that would have taken 10 years of computing hours for the most powerful supercomputer two years ago take just a year on Titan (roughly, since Linpack—the benchmark used to measure supercomputing performance—is not exactly representative of real-world supercomputing performance). Tasks that take an immense amount of computing time today – such as precision weather forecasts, gene sequencing, airplane and automobile design, protein folding, etc. – will continue to be streamlined as newer and more efficient processors/software are designed. By 2018-2019, the top supercomputer should reach a sustained performance of an exaflop (i.e. 1,000 petaflops)—this is both SGI’s and Intel’s goal. IBM believes that such a system is needed to support the “Square Kilometre Array”—a radio telescope in development that will be able to survey the sky 10,000 times faster than ever before, and 50 times more sensitive than any current radio instrument—and will provide better answers to the origin and evolution of the universe. The ongoing “democratization” of the supercomputing industry would also result in improvements in solar panel designs, better conductors, more effective drugs, etc. As long as global technology innovation isn’t stifled, the outlook for global productivity growth – and by extension, global economic growth and standard of living improvements – will remain bright for years to come. Advances in material designs would also propel the private sector’s efforts to commercialize space travel and reduce the costs of launching satellites. Should the quantum computer be commercialized soon (note that quantum computing advances are coming at a dramatic rate) we should get ready for the next major technological revolution (and secular bull market) by 2015 to 2020. Make no mistake: The impact of the next technological revolution will dwarf that of the first and second industrial revolutions.

Filed Under: Energy, Productivity, Technology

The Art of Short Selling

November 16, 2012 By cbcapitalresearch

The origination of this quote is unknown but it is commonly attributed to John Pierpoint Morgan, or his long-term business partner, James J. Hill (immortalized in The Northern Pacific Corner of 1901):

““Remember, my son, that any man who is a bear on the future of this country will go broke.”

As long as capitalism is allowed to function (with just enough regulatory meddling to weed out the bad apples), I generally agree with this statement. In the long-run–barring a sizable Black Swan event (in which case we have other things to worry about)–the trend of equity prices and dividends is up. Shorting the market on a consistent basis is a sure way to ruin.

That said–given the “creative destructive” nature of the global economy and stock market–there is definitely a place for short-selling selected companies or industries.

Let us backtrack and define why. Here are some universal axioms.

We understand from the Second Law of Thermodynamics that the entropy of the universe, and that of the earth, is constantly increasing.

As such, it takes a tremendous and increasing amount of energy to hold a system or company in equilibrium. Any energy expanded on this endeavor (e.g. keeping the human body nourished) takes a giant toll on our surrounding environment, and sooner or later, things will fall apart. The beauty of the capitalist system is that it allows these changes/transformations to take place on a natural and gradual basis, unlike “static systems” such as various 20th century communist systems (such static systems tend to fall apart overnight as they were not allowed to evolve over time).

That is, increasing entropy + capitalism system = consistent short-selling opportunities.

While this formula sounds tempting, I always keep in mind that my criteria for shorting a stock is very strict. Firstly, I never short any stocks in the beginning of a cyclical/secular bull market cycle. This is the point when the WACC has peaked, liquidity has improved, and risk-taking is increasing. The Advance/Decline (A/D) line in all global stock markets troughs and starts to rise. This is also when the stock prices of the most leveraged and badly managed companies rise the most.

A good case can be made for shorting stocks/industries as the bull market matures–such as when the NYSE A/D line topped out in April 1998; or when it peaked in 1969. In the latter, many stocks that were not in the “Nifty Fifty” were good subsequent shorting candidates.

Now, I never short because of overvaluation alone. I learned that lesson as a college sophomore when I shorted YHOO in early 1998 (thank goodness I wasn’t too dumb to cover after it started going against me). Rather, I only short stocks that fit one of the three following criteria:

1) IMHO, a company that is going bankrupt within the next 12 months;

2) If a company has fraudulent accounting or a fraudulent business (which I DO NOT have expertise in); and

3) A company that has an obsolete business model.

Even shorting a company that fits into 3) is very difficult as it could take years for the market to realize that a company has an obsolete business model (e.g. K-mart, A&P, or even Dell) so financing would generally still be available to keep the company as an ongoing concern (and there will be intermittent rip-roaring rallies). The best stocks to short are those that make you 50% while you are out at lunch (such as shorting Delta and Northwest Airlines in late 2005)–not those that make you 50% (in the best case scenario) while giving you an ulcer. That said, we need to recognize that such shorting opportunities don’t come every day. More than buying a stock, patience is the key to finding shorting opportunities.

Filed Under: Short Selling

The Superclass: A Rational (Investor’s) Perspective

November 4, 2012 By cbcapitalresearch

It’s that time of the election cycle again. Many frequent musings I overhear include:

“This is one of the most important Presidential elections.”

“The market is going to sink by 30% and the U.S. is entering a recession.”

“The Fed shouldn’t be doing this or that, and the Fed should be abolished.”

This is all random noise, and ultimately a waste of time. It doesn’t matter what you or I think. It only matters what Fed Chairman Bernanke, the ECB, IMF, Angela Merkel, and the new Chinese government think. Unless you are Bill Gross or Larry Fink and have a direct line to Treasury, I won’t care about what you have to say unless you are better at getting inside their heads–as well as the heads of large institutional investors–than I am. If you failed to time the last two major peaks of the global stock market (i.e. early 2000 and late 2007), then you have failed your clients–and should get and stay out of the investment industry.

To quote French dramatist, Jean Anouilh:

“God is on everyone’s side … and in the last analysis, he is on the side with plenty of money and large armies.”

To gauge the sentiment of global policy makers and large financial institutions, you need to at least read Bernanke’s two major publications (“Inflation Targeting” and “Essays on the Great Depression”) and to get inside his head regarding what the Fed will do today. If you had read both books before the late 2007 to early 2009 crisis (which we did), you’d have had a much better idea on Bernanke’s next steps on a real-time basis during and after the financial crisis. It is unacceptable to be learning and reading about things after the fact.

It is also unacceptable to write a long commentary when one could be brief. So here goes.

Today, we know that:

1) US Treasury rates remain at historic lows; therefore, the US government will not cut Federal spending
2) Using the same logic, neither would they increase US taxes
3) And yes, the Fed will inflate–the Fed is already doing this through QE3 with $40 billion of MBS purchases on a monthly basis

A currency regime is only sustainable if the underlying currency is allowed to be debased on a small and consistent basis. It is laughable to hear young Americans advocating for the return of the Gold Standard, when these same Americans (especially the so-called Jeffersonian “yeomen farmers”) were advocating for a bimetallic standard and rallying behind William Jennings Bryan’s “Cross of Gold” speech in 1896. It also did not occur to these same individuals that a true gold standard never existed in the United States. Chaos reigned after President Andrew Jackson killed the Second Bank of the United States. Banks issued their own bank notes and inflated the economy through the normal credit cycle, in spite of the so-called gold standard. The “gold standard” subsequently became a strait jacket on credit creation once the down cycle hits–thus accentuating the busts. For example, at the peak of the Panic of 1873, the NYSE closed for 10 days, and 36% of all corporate bonds defaulted from 1873 to 1876. The latest financial crisis pales in comparison.

With regards to U.S. interest/Treasury rates, we also know that there exists a shortage of global risk-free assets. According to numerous studies, there will at least be a shortage of $9 trillion worth of risk-free assets in the next five years due to the destruction of risk-free assets during the European sovereign debt crisis; as well as the implementation of Base III requiring higher capital standards of global banks.

That means there will be a rush to purchase more US Treasuries, no matter where US domestic inflation lies. By the way, there is no hard rule that nominal interest rates have to track inflation; nor any hard rule that nominal interest rates have to be positive. In fact, my base case scenario is for the U.S. Treasury Bill rate to decline below 0% sometime in the next several years.

Besides, we also know that inflation is nowhere near as “sticky” as it was in the last inflationary cycle during the late 1970s (culiminating in the peak of the gold price at $850 in January 1980). A comparison to the late 1970s to 1980 is thus erroneous. Inflation was very sticky in the 1970s given the rigidity of wage increases due to the power of unions and the fact that US labor was mostly domestic in nature. Today, unions no longer hold any power; and US labor wages are tied to global wages due to outsourcing.

So in a nutshell, yes, the Fed will continue to ease. And no, the government will not spend less; nor will it increase taxes. And yes, interest rates will remain low until at least the next Presidential election. And yes, what you say does not really concern me, unless you happened to be in a “Top 50 list” of global policymakers or a fund manager with >$100 billion in AUM. And at the end of the day, it doesn’t matter whether you agree or disagree with these global policies. As an investor, my concern is only about making money for my clients. And outside of that, my time could be better spent with family and friends rather than discussing the questionable virtues of a “sound currency” or “sound policy”–whatever that means.

Filed Under: Behavioral Finance, Euro Zone, Gold, Monetary Policy

Euro Exit Remains on the Table

October 22, 2012 By cbcapitalresearch

Despite the latest decline in Italian- and Spanish-German 10-year sovereign spreads (to 316 and 377 bps, respectively), the future of the Euro Zone remains in jeopardy. While there has been talk of a European banking union (which is the minimum requirement to keep the Euro Zone intact, in our opinion), German policymakers remain in firm control and are still stuck on “normal policymaking” mode. As the last two years have beautifully demonstrated, both austerity measures and the policy of “kicking the can down the road” are no longer viable. Given the horrible demographics in Western Europe, the bureaucratic red tape, and a general slowdown in the BRIC countries, there needs to be a combination of unprecedented pension/health reforms, employment reforms, as well as quantitative easing from the ECB and a Euro devaluation. Failing such a move, it is likely that one or more Euro Zone peripheral country will default and/or exit the Euro. Note that Intrade.com is still pricing in a 49% chance that one or more country will drop the Euro by the end of 2013:

While today’s 20- and 30-something investors cannot conceive of a Greek or any sovereign default, it is actually a quite common occurrence (Argentina was the last major country to default in January 2002). A partial default and devaluation becomes immensely attractive as the costs of default (e.g. domestic investor losses, a higher yield premium as the country borrows again, etc.) declines relative to the costs to sustain payments of a ballooning debt. A recent Richmond Fed paper (2007) (“The Economics of Sovereign Defaults”) shows that based on empirical evidence, sovereign defaults are very common throughout history. Spain defaulted six times between 1550 and 1650, while France defaulted eight times between 1550 and 1800. Between 1820 and 2004, there were 250 sovereign defaults by 106 countries. The following table shows a list of sovereign defaults from 1824 to 2003 grouped into seven temporal clusters.

More important, the Richmond Fed paper also suggests that the costs of default have actually declined over the last century, given the rising competition to supply sovereign capital between international creditors. For example, in the 19^th century, international lending was dominated by a few major lenders, such as Rothschild, Barings, Schroders, and Morgan. These banks can threaten to shut out borrowing countries in the future if they defaulted. Today, international lenders can no longer do so, given the huge variety of potential lenders, such as hedge funds, private equity funds, sovereign wealth funds, fixed income mutual funds, and even ultra-high net worth individuals. In other words, there will come a point (likely next year) when it becomes highly attractive for Greece to default, assuming the ECB does not step in with a more aggressive QE package or a regional banking union. The lack of fear in the market (as indicated by the relatively low VIX reading of 17.06) is also concerning from a bull’s standpoint.

Filed Under: Euro Zone