TCS Daily


The Investment Gods Are Angry

By Steven Selengut - January 14, 2009 12:00 AM

The Working Capital Model (WCM) is an historically new methodology, but with roots deeply imbedded in the building blocks of capitalism, and financial psychology--- if there actually is such a thing.

The earliest forms of capitalism sprung from ancient Roman mercantilism, which involved the production of goods and their distribution to people or countries around the Mediterranean.

The sole purpose of the exercise was profit and the most successful traders quickly produced more profits than they needed for their own consumption. The excess cash needed a home, and a wide variety of early entrepreneurial types were quick to propose ventures for the rudimentary rich to consider.

There were no income taxes, and governments actually supported commercial activities.

The investment gods saw this developing enterprise and thought it good. They suggested to the early merchants, and governments that they could "spread the wealth around" by: (1) selling ownership interests in their growing enterprises, and (2) by borrowing money to finance expansion.

A financial industry grew up around the early merchants, providing insurances, brokerage, and other banking services. Economic growth created the need for a trained work force, and companies competed for the most skilled. Eventually, even the employees could afford (even demand) a pieceof the action.

Was this the beginning of modern liberalism? Not! The investment gods had created the building blocks of capitalism: stocks and bonds, profits and income. Stockowners participated in the success of growing enterprises; bondholders received interest for the use of their money--- the K.I.S.S. principle was born.

As capitalism took hold, entrepreneurs flourished, ingenuity and creativity were rewarded, jobs were created, civilizations blossomed, and living standards improved throughout the world. Global markets evolved that allowed investors anywhere to provide capital to industrial users everywhere, and to trade their ownership interests electronically.

But on the dark side, without even knowing it, Main Street self-directors participated in a thunderous explosion of new financial products and quasi-legal derivatives that so confused the investment gods that they had to holler "'nuff"! Where are our sacred stocks and bonds? Financial chaos ensued.

The Working Capital Model was developed in the 1970s, at a time when there were no IRA or 401(k) plans, no index or sector funds, no CDOs or credit swaps, and, a whole lot less risky product for investors to untangle. Those who invested knew about stocks and bonds; investment-qualified trustees protected workers pension plans.

The WCM was revolutionary then in its breakaway from the ancient buy-and-hold, in its staunch insistence on QDI selection principles, and in its cost based allocation and diversification disciplines. It is revolutionary still as it butts heads with a Wall Street that has gone madwith product differentiation, value obfuscation, and short-term performance evaluation.

Investing is a long-term process that involves goal setting and portfolio building. It demands patience, and an understanding of the several cycles that both create and confuse the environment in which it takes place.

The WCM thrives upon the cyclical nature of the process while Wall Street ignores it. Working capital numbers are used for short-term controls and directional guidance; peak-to-peak analysis provides longer-term performance analyses.

In the early 70s, investment professionals compared their equity performance cyclically with the DJIA, over the time from one significant market peak to the next--- from the 11,400 achieved in November 1999 to the 13,930 achieved in November 2007, for example. Equity portfolio managers would be expected to do at least as well as the Dow over the same time period, after all expenses.

Another popular hoop for investment managers of that era to jump through was Peak to Trough performance. Managers would be expected to do less poorly than the Dow during corrections, like the 33% drop between November 99 and September 02, or the much steeper 40% variety that we are immersed in today.

Professional income portfolio managers were expected to produce secure and increasing streams of spendable income, regardless. Compounded earnings and/or secure cash flow were all that was required. Apples were not compared with oranges.

Today's obsession with short-term blinks of the investment eye is Wall Street's attempt to take the market cycle out of the performance picture. Similarly, total return hocus-pocus places artificial significance on bond market values while it obscures the importance of the income produced.

WCM users will have none of it; the investment gods are angry. (Google Peak-to-Peak or Trough-to-Trough to see how far a field the financial community has strayed.)

The WCM embraces the fundamental building blocks of capitalism --- individual stocks and bonds and a few managed CEFs in which the actual holdings are clearly visible. Profits and income rule.

Think about it, in a working capital world, there would be no CDOs or multi-level mortgage mystery meat; no hedge funds, naked short sellers, or managed options programs; no mark-to-market lunacy, Bernie Madoffs, or taxes on investment income.

In a working capital portfolio today, lower stock prices are seen as a cyclical fact of life, an opportunity to add to positions at lower prices. There has been no panic selling in equity holdings, and no flight to 1% Treasuries from 6% Munis. In a WCM portfolio today, dividends and income keep rolling, providing income for retirees, college kids, and golf trips.

Capitalism is not broken; it's just been too tinkered with. The financial system is in serious trouble, however, and needs to get back to its roots and to those building blocks that the Wizards have cloaked in obscurity.

Let's stick with stocks and bonds; lets focus on income where the purpose is income; let's analyze performance relative to cycles as opposed to phases of the moon; let's tax consumption instead of income; let's not disrespect the gods.

Amen!

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23 Comments

Back to basics
All we have to do is return to the market fundamentals, eh?

Well then, if you have a shared system of ownership, you have a tradable amrket in those shares. And given that, some will go up and some will go down.. so you'll have a market in hedges, derivatives, arbitrage a futures market and complex forms of risk management.

Which brings us right back to where we are now.. only without any police to guard us from pickpockets.

I fail to understand the dogma being touted here, where a market with rules, inspectors and auditors makes us less compliant, while a totally uncontrolled market will make us more compliant. Huh?

There is a certain elegance to having a pure, uncontaminated system that only follows its own internal logic. Unfortunately, the planet is inhabited by real people as well. And if the financial system goes unregulated it would appear that the logical endgame would be to have a winner.

That is, the smartest guy in the universe would end up owning everything. I'll confess I'm more human-centric than that. I'd like the game to be managed so that all the players can stay alive and in it. That is, a game without absolute winners. In the real world that would make us all winners, in the sense that we could continue participating in life on earth. And not have to starve for a few years whenever investment dried up.

It has been said that it's fine to take the long view.. but when we go hungry we don't eat today and we don't eat tomorrow. Let's remember what the money was supposed to help us do.

Wasn't Bernie Madoffs alive and kicking in the 1970s? Just wondering
And no taxes on investment income? He must be dreaming.

I am NEVER into ad hominem attacks.

That's why I didn't use another word that starts with dr and ends in nk !!!

WHY would the smartest guy want own everything?
Someone who is really smart will understand that if he wants to prosper, he needs to help others prosper.

Why would a really smart person want to be super rich but live in a place like Haiti or Mexico?

The real smart person would want to live in a place like Switzerland.

Rising tides lift ALL boats. That is a very simple concept that you don't seem to understand.

Too big to fail
That's a fine sentiment you espouse.. and one I would agree with. A wise man would spread the wealth, not hoard it. Otherwise his neighbors would envy him, and bring him low. Or, if not that, in time he'd just get tired of dining on pheasant tongues while looking at all the neighbors starving. So depressing...

But in reality what we're seeing is a long game being played out.. the round of mergers and acquisitions to decide who ends up with the whole enchilada. And since every few years the whole thing goes up in smoke, they all have an eye on becoming "too big to fail", so they can operate without a net and still qualify for a federal bailout.

What happened to that $350 billion Paulson handed out to his friends? Much of it went into M&As; none went into loans. They know how the game is played. And were buying insurance against having to ever pay the consequences of their own misdeeds.

You assume that the financial world is being run by wise men, philosophers. But it's not, any more than our foreign policy is being run by statesmen. In the society we have created it's next to impossible to stay uncorrupted and attain any sort of stature or power. Those already at the top would never allow it.

"Rising tides lift ALL boats. That is a very simple concept that you don't seem to understand."

Econometrics tells us differently. The money supply has been greatly expanded by bankers and bond merchants. NONE of these new funds have trickled down to the paychecks of ordinary workers. And in fact American productivity has languished in an environment where all goods come from abroad, and the only thing we make is the money our suppliers use for transactions.

It's a fine sentiment.. but the rising tide has only swamped those of us who've been stuck on the bottom.

What did Carnegie do with his money?
Maybe I should rephrase, WISE people understand that increasing economic activity benefits all.

Carnegie made his wealth by increasing productivity, just as Bill Gates enabled leaps in productivity. Everything you advocate would prevent another Gate or Carnegie.


"What happened to that $350 billion Paulson handed out to his friends? Much of it went into M&As; none went into loans. They know how the game is played. And were buying insurance against having to ever pay the consequences of their own misdeeds."

YOU are the one who wants BIG government. Be careful what you wish for.

Your bud Hugo has to resort to capitalism as his socialism is going broke.


"You assume that the financial world is being run by wise men, philosophers. But it's not, any more than our foreign policy is being run by statesmen. In the society we have created it's next to impossible to stay uncorrupted and attain any sort of stature or power. Those already at the top would never allow it.

YOU are the one who believes that if only the 'right' man is in charge, government will be great.

It is I who have been promoting limited government precisely because of corruption and ineptitude, but you want MORE government.

" the round of mergers and acquisitions"
Citibank is breaking up.

The big merger with AOL Time Warner was not very successful.

basics
You talk like it's all a zero-sum game, but it's not. If the market if free, and people are free, every trade is voluntarily, sum-sum situation.
This notion of yours of one guy ending up owning everything is like the old marxists used to say about how one company would monopolize the whole economy. That's all nonsense before and now. It's not a Mad Max world.

Pool full of sharks
Anyone able to read will have noticed that our economy propels companies to greater and greater size. Once the banks became deregulated, for instance, they immediately began swallowing one another up. Local powerhouses like City Bank of NY became national giants, swallowing innumerable competitors.

The trend still continues. The misspent bailout money Paulson just handed over went in large part to finance a further round of mergers and acquisitions.

In the publishing industry we're seeing the same thing.. and it's becoming the death of the newspapers. The costs of hostile takeovers have grown so great the newly consolidated outfits can't manage their acquired debt.

All this economic activity is in fact zero sum. It doesn't add one whit to the products or the services being offered. The point of it is to (a) make the company "too big to fail" so they can hopefull become elgible for a bailout when trouble drops on them, and (b) justify even more insane salaries for the big boys on top. It's a serious failure of capitalism as presently practised.

In an environment where viable companies are a constant target for hostile takeovers, just where do you get that "every trade is voluntarily, sum-sum situation"?

Finally, just a tip: not everything is a "Mad Max world". Try to build a broader vocabulary, for the sake of reader interest.

After the dinosaurs came the mammals
Huge dinosaurs ruled the earth, for a while.

Things changed and the lowly mammals living underground in the dinosaur's shadow inherited the earth when the dinosaurs could not adapt.

If a free market is allowed by the state, dinosaur corporations must adapt or die.

I like your analogy
So if the big dinosaurs ate the little ones, they reached a state where they ruled the earth for something like 160 million years.

Then it took an asteroid strike to nearly destroy life on earth, before the little monkeys could scamper down from their tree tops and safely walk on the ground.

In your analogy, wouldn't the asteroid strike (required before the system could change) be the confidence meltdown we're seeing in our debt-based financial system?

It is working today
Viruses mutate continuously to challenge all higher orders.
Those that cannot adapt, die.

Of course we try to kill the virus before it can threaten just as the big corporations try to kill off their competition using the power of the state.

Do you understand our distant ancestors created a synergistic bargain with another bacterium? Mitochondria have unique DNA and are protected by our cells to create energy.

I meant
I meant if the markets 'were' free, because they aren't now. Some companies or individuals will try to collude with the government for monopoly situations, but if the government didn't have the power to grant such favors it couldn't happen at all.
You notion of one company controlling everything is also phoney because there is the supposition that when they control too much, they will charge untoward prices for everything. But this assumption is also false because other companies will provide alternatives, UNLESS prevented by government interference.
Regarding mergers etc. I prefer to go to one supermarket and buy everything I need instead of first stoping by the butcher, then going over the the bakers, they the pharmacy, then...... Supermarkers, and WalMarts came about because people like them, not because of evil intend by monopolists.
The newspapers arey dying not because of hostile takeovers but because those MSM papers have abused their position by being too biases, by new media like the internet, many more chanels on tv, etc.

Useful idiots
It's becoming very well known that industry has always espoused a very capitalist, private property oriented free enterprise system.. but that in reality they always accumulate political clout as soon as they can to get Big Government to tilt the playing field in their favor. The system we've had for quite some time (since Truman) is one that privatises profit while socializing costs.

The only people failing to notice this are capitalism's "useful idiots".. people who know the theory but don't follow the actual practise.

Look at the industries enjoying prominence now. Energy and agriculture have been growing fat through government influence and subsidies. And we see a very discernible patern of elimination of the little players before they can become competition for the biggest ones.

The defense and war profiteering industries are the worst. They actively have to cause government to engage in wars without end before they can sell their products. Their profit line is built on perpetual fear.. and the deaths of little people around the world) collateral damage). From time to time an attack on the "homeland" is required before our fears can be redirected from one old enemy to a more current one.

The old industries, built on jobs and labor, have all deserted our shores through government legislation, relocating to places whose starvation wages and absence of environmental or labor laws enhances the bottom line. Thus we enjoy lower prices.. but fewer of us have jobs.

Another piece of Roy's Ignorance
Our economy does not propel companies to ever larger sizes.

The purpose of a company is to be profitable, not larger. For those that overestimate the size of the market and economies of scale; our economy will force them to contract. if you don't think so, ask Starbucks-their empire was based on selling coffee along with a bunch of leftist-feel good stuff. However, THE ECONOMY is checking their empire and they are not closing shops. Some contract to zero-unless they remain puffed up by government. So it is, GM and Chrysler and a bunch of banks remain puffed up and Circuit City disappears...

Admitting it is the first step in recovery.
So why do you want the government to have MORE power that industry can bribe?

idiots
What you are pointing out when you say industry wants big government to use its clout to gain favor is not a problem with capitalists, but a problem of governments. If there were no big government with the power to manipulate the economy, then it couldn't happen, then there would be real capitalism(private property, free markets, rule of law).
Rent seekers do not qualify.

roy's lack of basic understanding
The smartest guy would only own everything if he were omnicient.

As it is, the bigger an organization gets, the harder it is to control.

Read up on the inefficiencies of scale some time.

You don't need govt to have rules.
Even if you did. This would not justify an infinite number of rules.

roy automatically believes that bigger must be better
Which is why he wants govt to control everything.

Every change is a potential asteriod strike
Those who adapt thrive, those who don't die.

It's easier for small companies to adapt than it is for big ones.

roy gets self referential again
roy notices that many companies try to get govt to help them.

Then he turns around and declares that this can only be fixed by making govt bigger and more powerful.

NeaRNoad wouldn't agree.

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