CFA Society Chicago Book Club:

The Billion Dollar Mistake by Stephen Weiss

The CFA Society Chicago book club met for their monthly meeting on June 16, 2015 to discuss “The Billion Dollar Mistake” by Stephen Weiss.  Mr. Weiss brings a wealth of knowledge and experience to the table as he has spent nearly 25 years on Wall Street working at Lehman Brothers, SAC Capital, and Salomon Brothers.  Coincidentally, he was booked on Flight 93 for a 9/11/01 departure though decided to postpone the trip to focus on pressing work at Lehman.  The event was a turning point in his life where he left Wall Street to move out west and start a hedge fund.  This is where he began thinking about his next phase in life and writing this book.  At the end of the day, a mistake is a mistake, whether it is a billion dollars, a million, or a buck.  This book presents several different case studies which can help us minimize the number of our future mistakes.  The book also provides several 101 type lessons in finance to help explain the various case studies.  The case studies involve the ponzi scheme of Madoff, AIG’s deviation from its core business, Aubrey McClendon’s excessive leverage at Chesapeake Energy, and activist investor Ackman’s divergence from his investment discipline.  To sum up a few of the key takeaways, we have put together the following bullets:

  • Never let your passion override your sense of discipline.  Always perform your due diligence and remember that times, facts, and investment scenarios are constantly changing.
  • Be careful of rushing into a market that is falling fast.  Let the knife fall.  It is better to fully understand the investment rather than impulsively jumping in.
  • Insider buying and selling must be carefully analyzed.  Understand the context and motivation for the transaction.  Insider buying isn’t always a buy signal.
  • Leveraging your portfolio can enhance your returns, but never over leverage to the point where you don’t have the necessary collateral to meet your margin requirements.
  • Know the investment discipline established by your manager and ensure they stick to their mandate.  Venturing outside their area of expertise leads to style drift and potential losses.
  • Short selling can be a dangerous strategy.  Remember that the market has an upward bias and going against it is similar to trying to beat the house.
  • Rarely does a fall in stock price equal an opportunity.  Prices move in response to new information resulting in a very efficient market.
  • Beware outsized returns.  They almost always indicate excessive risk.  Be sure you are willing and able to take on the risk, otherwise stay conservative.
  • Don’t just diversify across asset classes; consider diversifying across investment managers which can lead to increased risk mitigation.

 

Upcoming Schedule:

July 21, 2015: On Saudi Arabia: Its People, Past, Religion, Fault Lines – and Future by Karen Elliott House

*(NOTE: Those who attend the July Book Club meeting will receive a free copy of “Superpower: Three Choices for America’s Role in the World” by Ian Bremmer)

August 18, 2015: Superpower: Three Choices for America’s Role in the World by Ian Bremmer

*(NOTE: Author Douglas Sisterson is attending the PDDARI meeting which takes place just before the book club meeting on 8/18. He will be discussing his book “How to Change Minds About Our Changing Climate”.

September 15, 2015: The New Cold War? Religious Nationalism Confronts the Secular State by Mark Juergensmeyer

October 20, 2015: TBD

 

To sign up for a future book club event, please click here:

http://www.cfachicago.org/apps/eve_events.asp

CFA Society Chicago Book Club Discussion:

The Forgotten Depression: 1921: The Crash That Cured Itself by James Grant

The CFA Society Chicago Book Club met for their monthly meeting on April 21, 2015 to discuss The Forgotten Depression, by James Grant.  We went around the room and shared our backgrounds and kicked off our discussion on the 1920-1921 “Forgotten Depression”.  About a decade before the Great Depression of 1929-1933, there was a volatile economic downturn that lasted from January 1920 to July 1921.  It could be said to be the last governmentally unmedicated depression with the hero being the one and only invisible hand.

A surprise to many was when the war ended in November 1918, the postwar depression and deflation most expected didn’t immediately happen.  Inflation was in the double digits during the war and continued into 1919.  When peace didn’t immediately yield deflation, many thought the inflated war time wages and prices were here to stay.  Increased prices invited speculation and the speculators were lured by the low and easy money.  Businesses that should have gone under stayed afloat due to the easy money and ability to refinance.  Investors, farmers, and businesses expected the double digit inflation to continue into the 20s.  It didn’t happen.  The auto industry ended up collapsing in 1920 as Ford and GM both invested based on their forecast of rising prices.  Farmers had it worse than autos as farmers borrowed heavily to plant fencepost to fencepost in anticipation of rising prices.  In NYC, National City Bank lent unwisely against the collateral of sugar in Cuba.  By 1921, prices collapsed to 1913 levels.  Finally people began to see that the speculative nature following the war had collapsed.  NYSE stock prices fell 40%, unemployment which was not yet measured was certainly in the double digits, corporate profits collapsed, exports halted, demand dried up, and there was a run on the banks.    Benjamin Strong who was governor of the Fed at the time was a believer in the classical approach to money and banking.  When Benjamin Strong reflected on what was to come, he advised that there will be heightened unemployment, there will be deflation, there will be hard times, but the bad times will end and the economy will move forward.

By 1922, we saw a liquidation of labor that turned out to be what launched the roaring 20s.  The period can also be described as the Great Inflation followed by the Great Deflation with the volatile recession lasting a short 1.5 yrs peak to trough.

 

Upcoming Schedule:

May 19, 2015: How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

June 16, 2015: The Billion Dollar Mistake: Learning the Art of Investing through the missteps of Legendary Investors by Stephen Weiss

July 21, 2015: On Saudi Arabia: Its People, Past, Religion, Fault Lines – and Future by Karen Elliott House

*(NOTE: Those who attend the July Book Club meeting will receive a free copy of “Superpower: Three Choices for America’s Role in the World” by Ian Bremmer)

August 18, 2015: Superpower: Three Choices for America’s Role in the World” by Ian Bremmer

September 15, 2015: TBD

 

To sign up for a future book club event, please click here:

http://www.cfachicago.org/apps/eve_events.asp

CFA Society Chicago Book Club Discusses

Bust; Greece, the Euro, and the Sovereign Debt Crisis by Matthew Lynn

The CFA Society Chicago Book Club met on March 17 to discuss Greece and how the debt crisis came to be and the outlook going forward.  Matthew Lynn’s 2011 book, Bust; Greece, the Euro, and the Sovereign Debt Crisis was a fantastic read and encouraged a very in depth discussion.

Just two short years after the collapse of Lehman Brothers, Greece faced mounting debts resulting from easy borrowing driven by cheaper rates after arguably fiddling its way into the Euro in 2001.  The Euro was created in 1999 to promote three key components.  1) Promote open trade across European borders minimizing FX risk, 2) Initiate a more dynamic, prosperous, and innovative Europe, and 3) Provide price stability with the intention of competing with the USD as a global safe haven currency.  Interestingly, countries like Portugal and Greece with much poorer credit quality were able to borrow Euros as easy as Europe’s strongest country, or Germany.  By becoming part of the Euro, countries resulted in a loss of national sovereignty and could no longer devalue their way out of debt as they did in the past.  Nor could they target a lower currency to export their way to growth.

Understanding Greece involves taking a look at the country’s history.  There have been predominantly two Greek families in power post WWII.  Post WWII, Greece never modernized while the North became industrial powerhouses.  Greece has had to rely on shipping, tourism, and agriculture.  They never heavily targeted investing in manufacturing like the North.  Greece has defaulted on numerous occasions including 1826, 1843, 1860, and 1893.  In 1997, the Greek Central Bank had to raise rates from 10% to 150% to stop the currency from going into freefall.  When evaluating whether Greece was suitable for the Euro, Greece was initially denied in 1999 but by July 2000, supposedly inflation was down to 5% and the budget deficit was only 1% of GDP gaining Greece entrance into the Euro effective 1/1/2001.  Once Greece switched to the Euro, we saw the Greek economy create strong growth but rising trade and budget deficits.  With low rates and the ability to borrow, Greece was riding an illusion of prosperity.  The 2004 Olympics held in Athens was a giant cost to the country.  Millions were spent on new stadiums that unfortunately tend to collect dust once the games are over.  In September 2004, it was reported by the Greek government that the accounting was incorrect and the country should never have been in the Euro.  The EU did nothing about it.  Greece continued to not play by the rules running up a higher and higher budget deficit to GDP.  Tax evasion and bribery has been common corruption we have seen in the country.  The Greek Pension system certainly doesn’t help the deficit as the retirement age is significantly lower than that of countries in the North.  Unmarried woman for example receive their parents pension if they are unmarried which discourages employment.  The Euro was not meant to be a currency you joined to become a stronger country, it was meant to only include the strongest countries to ensure price stability.

It was not only Greece that was incentivized to borrow at the ultra low rates once joining the Euro.  We saw very similar issues in Portugal.  Spain’s borrowing fueled a real estate boom that resulted in high growth but with relatively low productive growth making Spain less competitive.  Ireland cut its corporate tax rate luring corporations from all over driving the per capita income to one of the highest in the world.  The lower ECB rates resulted in Ireland’s excessive borrowing and an artificial property boom.

Germany on the other hand was running a surplus while the Club Med countries were running deficits.  Postwar Germany is said to be an economic miracle.  West Germany had strong growth driven by a stable currency, low inflation, hard work, brilliant engineering, and a frugal mindset.  Germany was not in favor of the Euro given their strong stable currency.  Germans tend to live within their means and avoid borrowing and credit cards.  The culture of Germany includes saving, living within their means, manufacturing, and frugality.  This all seems to diverge from the cultures of the Club Med countries which has led to where we are today.

After just under a decade, once 2009 hit following the credit crisis, we began to see the negative impacts of the excessive borrowing of peripheral Europe.  We saw downgrades from S&P and Fitch in late 2009.  Stocks in Greece began to fall, yields spiked, and bailout discussions began.  Germany did not want to bailout Greece.  The No Bailout Treaty of the EU also stated that each member state was responsible for its own public finances which was a precondition for long term growth in Europe.  From the end of 09 through May 2010, much debate and meetings took place to resolve the European sovereign debt crisis.  To protect the Euro, Merkel ended up compromising breaking the No Bailout Treaty and coming together with the IMF to bailout Greece, Portugal, and Spain among others in the trillion Euro bailout.  This resulted in the ECB for the first time buying government bonds helping to lower rates and increase prices to stabilize the Club Med countries.  Austerity programs across the Club Med countries were initiated and confidence was restored in the Euro.  Government salaries were frozen and social programs were cut.  Italy was forced to cut wages or suffer stagnation.  The question remaining was, did the EU and IMF provide a cure, a short term fix, or poison to the region?

It seems as though Greece has tended to follow the script of new government and new spending program, then falling GDP, austerity, and another EU bailout.  Excessive borrowing without investing in manufacturing led Greece to where it is today.  The author believes that once the moral hazard of providing bailout funds was initiated, the Euro was destined to fail.  He believes it was a major policy mistake to put politics in front of economics by creating a single European state.  He argues that bringing together the very strong economies of Germany and France with that of Greece, Ireland, and Portugal was a major mistake.  He argues that the markets should decide the outcome and it would have been better long term to let Greece go bust rather than provide a bail out.

Upcoming Book Club Schedule:

April 21, 2015: The Forgotten Depression: 1921: The Crash That Cured Itself by James Grant

May 19, 2015: How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

June 16, 2015: TBD

July 2015: TBD

Aug. 2015: TBD (NOTE: Those who attend the Aug Book Club meeting will receive a free copy of Superpower: Three Choices for America’s Role in the World by Ian Bremmer. This is his new book and was released May 2015.)

Sept. 2015: Superpower: Three Choices for America’s Role in the World by Ian Bremmer

Sign up for a future book club event.

 

Book Club Discussion: “The End of Copycat China: The Rise of Creativity, Innovation, and Individualism in Asia”

The CFA Chicago Book Club met on Feb. 17 to discuss The End of Copycat China: The Rise of Creativity, Innovation, and Individualism in Asia by Shaun Rein.  Below is a summary of the discussion based on the reading:

The End of Copycat China by Shaun Rein is a sound read.  We started off our discussion by opening it up to the members of the CFA Society Chicago book club and let each individual share a little bit about them and what they found interesting in the book.

We discussed the innovation cycle which you can isolate into three stages.  The first being the copycat stage.  This is where an emerging economy takes developed economies technology and implements into their own markets to initiate growth.  This is a natural process of economic evolution where there is plenty of low hanging fruit.  When there is plenty of low hanging fruit coupled with poor intellectual property rights, individuals will not have the incentive to innovate hence stage 1 of the innovation cycle.

Stage 2 of the innovation curve is when companies start to innovate specifically for their target market.  For example, stage 2 would involve taking advanced technologies and tailoring to the Chinese people.

Stage 3 is innovation for the world.  There is no longer the low hanging fruit, the advanced technologies have been tailored to the emerging economy, and now companies engage in R&D, intellectual property rights are strong, and innovation becomes the way to new long term sustainable growth.

Pollution was obviously a hot topic.  There was a point when Beijing had an AQI (Air Quality Index) of 700!  To put that in perspective, Los Angeles hovers around 20 and Paris officials will stop half of the city’s traffic if AQI hits 50.  China has an abundance of coal.  70% of their energy needs come from coal.  Increased auto sales have also added to the pollution problem.  They have only recently begun uncovering possible shale formations which they will use U.S. advanced technologies in hydraulic fracturing and horizontal drilling to uncover oil & natural gas.  Alternatives to coal are solar, wind, or nuclear power.  China is in the process of building nuclear reactors to promote clean energy though it is going to take many years to get up to their target.  Solar and wind are both not as stable as coal and given coal is in abundance, coal is relatively inexpensive which further promotes toxic carbon dioxide emissions.  The air can be so bad that many people plan their entire day around the AQI while checking their smart phones like they check the stock market.  E-commerce is soaring because people don’t want to go outside.  They rather hire a delivery guy to bring them groceries than risk going outside.  There are 8-year-old girls developing cancer from the poor air quality.  N95 masks are what everyday people need to protect themselves.  Several marketing strategies result from this.  For one, you start to see designer or Sponge Bob N95 masks on an everyday basis.  Another example is having malls that offer garage parking that allow for consumers to spend the entire day at one location.  For example, having a movie theater, restaurants, shopping, gym, and many other options to avoid having to go outside.  Expatriates described it as living on Mars.  Given the excess natural gas production in the U.S., the U.S. will be at an exporting advantage as the U.S. begins to liquefy natural gas or convert it into methanol to sell to the Chinese to promote clean energy.  The Chinese will be spending billions over the next 50 years investing in clean energy for land, water, and air.

The Chinese are evolving in their brand taste.  They are saying good bye to the flashy giant Gucci and Louis Vuitton logos and focusing more on brands that better represent China and their culture.  In addition, they are saying goodbye to the mainstream brands and moving towards a higher degree of exclusivity.  The knockoffs are starting to fade.  Status seems to be important throughout the history books.  The new status symbol is sending your kids to elite boarding schools in the U.S.

The emerging middle class in China is growing strong at 875M people.  The growth rate is high and they have a higher degree of confidence than the middle class.  They plan on buying houses, cars, and traveling in the future.  There is a changing dynamic going on in travel.  Its seems as though the middle to upper class are looking for places that are more exotic where other Chinese haven’t been.  Think New Zealand, Maldives, Mauritius, or South Africa.  Paris and Rome have become too common just like the mainstream clothing brands.  They don’t want to just copy westerners any longer.  They want brands specific to China.

Food safety is a driver of consumer spending.  KFC in the 90s is a great example.  The Chinese are going to pay a premium for food and health to help offset the issues with pollution.  Stay far away from the street vendors, at least the ones that don’t have anyone in line.

 

Upcoming Book Club Schedule:

March 17, 2015: Bust: Greece, the Euro and the Sovereign Debt Crisis by Matthew Lynn

April 21, 2015: The Forgotten Depression: 1921: The Crash That Cured Itself by James Grant

May 19, 2015: How Latin America Weathered the Global Financial Crisis by Jose De Gregorio

Sign up for a future book club event.