The other point that the article makes rings truer, that making iPhones isn’t much fun:

. . . Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.

A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.

Assembling iPhones is a repetitive and gruelling manual job. It is hard on the eyes, on the stamina and probably on the spirit. The majority of the workers at the Foxconn (also known as Hon Hai) plant are young, resilient recent immigrants to the city, for whom the alternative to doing this is working on the family smallholding or some other menial job in the Chinese boondocks. They don’t need engineering degrees, though do need skills and motivations I and probably a lot of Americans don’t have, e.g. being able to put small parts together in exactly the same way, again and again for hours and hours all the while standing up, Don Rumsfeld like. Being in a position where you can be woken up at 12.30 am to do a 12 hour shift fortified only with a biscuit and a cup of tea is not something I would wish on my fellow countrymen — at least not all of them.

I don’t think the NYT seriously wants their fellow Americans to work like this either (and by the way, since when was a foreman’s job on an assembly line “middle class”?). It’s the sort of thing workers in developed countries stopped doing since the 1970s and 1980s, and trades unions have been fighting against for decades before. We shouldn’t go back.

Don’t get me wrong — I don’t disparage the necessity of mind-numbing manual work, I certainly don’t look down on those who do it, nor hate the bosses who oversee them. It is a fact of life. However, it has to be for something worthwhile, however, and in large part I think it is in the case of Foxconn and Apple. For the Turkish and Greek Gastarbeiter in Europe in the 1950s and 1960s factory manual labour was a stepping stone to better things, and similarly, one hopes the Chinese building iPhones will be able to save some money to take back home or stay in the city to start a business, get married and educate some (well, typically only one) kids, or, at worst, buy an xBox. You have to look at the alternatives open to the people doing the work; for a Chinese late teen or 20-something the more realistic alternative to the Foxconn plant is a life of rural toil, tedium and poverty. For the average US teen it would be college (and some debt) and/or relatively bearable job in a service industry, possibly cutting hair. The American shouldn’t have to compete with his Chinese counterpart — the menu of his or her life choices is so much richer.

The other idea implicit in the article I have a problem with is that iPhones and the physical location of the plants that supply them have disproportionally favoured the Chinese economy over the US. Well, when it comes to assembly, the amount that stays in China is an infinitesimal fraction of the total added value of an iPhone. Foxconn earns something like a 5% gross margin and a 2-3% EBIT margin on its assembly business and for business from Apple it might even be less. Indeed, some analysts think Foxconn only earns a positive margin because it can throw in a few components of its own into the deal. Its notable that no-one else has ever been able to take any of Apple’s assembly business from Foxconn. Many have tried and lost money, such are the competitive razor thin margin this business operates at.

Compare that to the 30% to 50% gross margins (and 20-30% EBIT) a semiconductor supplier earns selling a chip into the iPhone — almost all the semi content in the iPhone is from US companies, and by no means not all the chips are fabbed in China, although I agree with the article that many are. I’m not even talking about the great margins that a software company selling code into the iPhone foodchain makes, nor the insanely great margins Apple operates at, just the hardware foodchain. Which part of that foodchain does the NYT really want American companies to be at?

My final comment is that the article ignores the flipside of the equation, the dual nature of employees like Eric Saragoza, the mid-level Apple engineer who  got laid off in 2002. Scant comfort for him of course, but he is also a consumer. The huge benefit of the constant price down in technology is that consumers get to be able to buy amazing, life changing products at increasingly affordable prices, while incentivising the companies who make them with great margins. iPhones and iPads have changed my life moderately, but have transformed the lives of millions of people in a more profound way. This is what technology does, and I don’t know another way of ensuring that it happens. Very often the ability to make something new and useful for significantly less is just as impactful as the ability to make that new and useful thing in the first place — it opens the door to new business models, to new uses, to things the inventors may not have dreamed of. Look at Tim Berners-Lee and the internet*. Benefits like these are immeasurable and general to all, and you only notice what happened later on, while Eric Saragoza’s job loss was immediate, specific, and personal. It makes a good, heart rending story. “Everything is slowly getting better for most everyone” should make a good story too, but in practice will be less affecting, and get fewer links.

Baruch is not an American and the decline of the middle class there is not his uppermost concern; in fact he cares as much about the Chinese factory workers toiling away at Foxconn. He thinks the dynamics of what the NYT is writing about is actually fantastic for almost everyone, and actually strengthens the global middle class by adding more people to it, in China. This is wholly a Good Thing, for all the problems we actually should be concerned about, like war, poverty, the environment, healthcare, education and the personal outcomes of ourselves and our fellow humans, all these things are mitigated by expanding the middle class, because only people with some disposable wealth of time and income are able to think about them.

* You think he ever thought he would end up using his invention for finding Angry Birds cheats like the rest of us? Of course not.

Tis (or, by the time I finish this post, ’twas) the season for pundits to give specific predictions for 2012 and a more pointless exercise has yet to be devised. Baruch isn’t going to waste your time doing this, for various reasons. The main one is that Baruch has long been convinced he is almost always wrong about almost everything. His only solace (and it is a big one*) is that everyone else is always wrong as well, and unlike him they don’t know it.

This year prediction seems a lot more difficult anyway. If Baruch is at all representative of bien pensant investor opinion the overriding emotion among practitioners today is a lack of confidence in anything, especially themselves. This is because almost without exception everyone traded like an idiot in 2011, both on the hedge fund side, where “slightly down” is the new “up”, and on the side of benchmarked long only funds. As you may know, Baruch is a professional investor and helps run one of these latter things. Looking at his peer group he is amazed, despite a mild underperformance, to find himself firmly in the top quartile in YTD relative returns. Despite this, he feels like a schmuck. How much worse must the average PM have fared, he asks himself. Just why has everyone done so badly this year?

Baruch has some ideas about why this is; a lot of it can be put down to the narrative of the year and investor positioning.  Overall, the majority of the active management community were extremely badly positioned for the key moves in the market in the back half of 2011. They were mostly long for the big August swoon associated with the US credit rating cut, and many compounded this by adding exposure into the decline too early — catching falling knives, in the parlance. Having finally understood the appalling ramifications of the European debt crisis, investors were nice and short, or in cash, for the quick but steep October rally that brought the major indices almost back up to the point at which they had broken down back again in August. Shellshocked, with what seemed had seemed a decent year now in tatters, all they were able to do in November and December was curl up in a foetal position, to derisk, and hope the kicking stopped.

A time of derisking, by the way, is a terrible time for those who are not derisking to make money. It means PMs selling positions that they like, and buying the ones that they hate. If everyone is doing this it makes for the market of Bizzarro World, where down is up and up is down. Good stocks, at best, make no traction, while bad stocks are likely to squeeze. November and December were marked by this worst of enviroments, what Baruch calls “high amplitude chop”. This had the effect on putting the kibosh on the few players left who still had any profits, and who had thus been less inclined (the fools) to join the mass huddle.

By the end of 2011, then, the performance-led derisking must have been largely complete, and at least some investors, if not the majority of them, are probably looking at trying their luck in a new year, with slates wiped clean, and having another go at earning those management fees again. Indeed the last datapoint in 2011 from ISI, who tracks these things, had the gross at hedge funds (a measure of how much of their capital they have deployed in short and long positions) at the same level as June 2008 — ie very low, crisis levels. Not at all what you would expect at the end of a year in which the S&P was only flat.

Just off that then, it would seem that maybe we don’t have to worry too much, and we could have a return to something approaching a normal environment where active management works again. In fact it is necessary to be mostly optimistic in this business, as a general rule. But then again I suspect I am merely trying to reassure myself because while people may be underinvested, there is also a very high degree of nervousness out there. It won’t take much to bring us back to derisk mode again, and if 2012 is another chop-filled  year like 2011 for active managers, well the only people who are going to be happy are the indexers. And they’re the enemy.

I would like to end the blogpost right there, and not talk about the things which are actively making me worried, such as $200bn in dodgy European sovereign paper to roll over, the apparent Chinese slowdown, nasty commodity trends and record high corporate margins etc etc, because thinking about these things makes me stressed out.

Happily, others have done that better than me**. So I sign off and wish my reader(s) a very happy and prosperous new year.

* knowing that whatever thesis you have in your head is likely to be wrong makes it much easier to discard it when it gets falsified, or when you think of something better. Knowing also that you are really quite thick makes it harder to worry about looking stupid (why live a lie?), and more money is lost trying not to look stupid than in any thing else you are likely to do in the stockmarket.

** Baruch is not sure whether The Interloper makes him want to retire from blogging or want to blog a lot more. Either way, it is grand he is around to be read. If he wants a hand on Euro Telcos he can drop me a line.

Baruch is also unamused by the people who are watching what appears
a train wreck with barely disguised glee, rubbing their hands in anticipation
of the Euro’s supposedly imminent demise, starting of course with the ejection
of Greece. Your celebrated correspondent has no particular love for the common
currency, not least the silly name (“Euro-“ is a prefix, he has always thought),
but once in, the likely costs of leaving are so awful as to make it imperative
to stay in. In the case of Greece, were it to drop out of the Euro, we would be
talking about the instant impoverishment of a modern democracy, whose citizens’  life savings would be wiped out (apart from the  very rich who are able to have accounts abroad, take that, Gini co-efficient!) and the bankruptcy of every exporting enterprise. There would be mass unemployment. Imports such as energy and medicines would skyrocket in price, creating shortages; basic services would likely break down. People would die. It would be less like Argentina, more like post WW1 Germany, or maybe Eastern Europe after the collapse of communism.

Within the living memory of politically active people Greece has fought a bloody civil war, and flirted with fascism. European leaders should probably pause before inflicting this sort of stress on one of the most politically dysfunctional and divided states in Europe, a relatively big fish in the Balkan backwater, itself no stranger to conflict.

Seriously, I wouldn’t want this Pandora’s box opened even
if I was short the Euro, which I am not and which I happen to think may be a
quite bad idea if you want to make money in the near future. Yet never mind the
Eurosceptics who are actually looking forward to it, everyone else seems to be
fairly resigned to it as well. Even clever people. Felix, for instance, sees a “chaotic collapse” of Greece as “inevitable”. Josh Brown cheers him on.

I think the very awfulness of what will happen if Greece is ejected from the Euro in a messy way (and until the treaty is changed there isn’t really another way it can happen) actually makes it more likely that it doesn’t happen. No matter how nasty a generation of austerity may be, it is a walk in the park in comparison with the likely alternative.

And that realisation may just have dawned in Greece last week.

What Papandreou’s referendum call did was to finally prevent the opposition from having their cake and eating it. For ages now, the main opposition party Nea Demokratia (together with all the other parties on the left and right) have been telling the Greeks that PASOK and Papandreou were “doing it wrong”. Had they been in negotiations with the so called Troika, they say, the aid package would be better for Greece. It’s bullshit, of course. In fact the Troika is deeply distrustful of ND, thinking them the more corrupt major party (by Greek standards) nationalist demagogues, tinged with incompetence. It was them after all, after a long period out of power, who fell on the state in the mid 2000s like a dog gobbling a sausage, not only purging even mid-level officials to replace them with their own supporters but also creating a hundred thousand new, underemployed, unsackable state workers for jobs that simply didn’t exist. It may have been the straw that broke the camel’s back. Greek politics was awful before, and god knows PASOK is, shall we say, not unbesmirched by the behaviour which has led the country to this pretty pass. But Nea Demokratia are real idiots, and I mean that charitably.

Bullshit or not, the politics of denial have worked. It’s natural to grasp at straws while in extremis; if politicans are saying Greeks don’t have to impoverish themselves to keep the Euro, they can be forgiven if some of it sinks in. PASOK is deeply unpopular, Papandreou (dubbed “Merkel’s Straw Man” by the Athens dailies, or at least the ones that are left) can hardly control his own party, and up until recently ND was likely to win any election that is called in the near future.

Papandreou must have been pretty sure that calling for a referendum would infuriate Sarko and Merkel, for obvious reasons. But I think his main target was every politician in Greece who has argued that Greeks had any sort of choice about austerity if they wanted to stay in the Eurozone. All those supporters the parties have given jobs to would be the first victims of any collapse and see their incomes smashed (private sector employees, those that still have jobs, could at least see their nominal wages adjusted upwards). ND and the PASOK old guard would immediately lose all legitimacy and relevance. Which is why the biggest storm of indignation against the referendum idea came from the Greek political class itself. Baruch was very pleased to see Antonis Samaras, the head of ND, on TV denouncing the referendum idea and stating flatly that the current bailout was the “only deal on the table”.

It’s no wonder Samaras wants an election as soon as possible; he has lost his only point of differentiation with PASOK and needs to get voted in before people realise that he was blowing hot air all these months. It doesn’t look like he is going to get it anytime soon; he has been out-maneuvered. He and his party no doubt have some dastardly plans to seize power, but with the threat of funds being withheld by the EU it is hard to see what he can really do.

So forget the Sturm und Drang of the announcement and the humiliations
of the immediate aftermath – look at the results. From here, no serious party
in Greece can tell their supporters that the current bailout is anything but
the best they can get. If you want to vote against the deal, you have to vote
communist or extreme right, and I have no doubt many will, but I do doubt they
will be let into any government. The Troika’s favoured outcome, a national
government, is in the process of being negotiated as I write this, with Samaras trying to holdit back, and better still, it looks like it is going to be stuffed with technocrats from Greece’s international diaspora, none of whom have a political base that needs to be satisfied with state-owned goodies, and who will be much more receptive to the advice of the Germans and others who have been put into every ministry as “advisers”. At least for now, Greece is in some form of receivership, which is where it belongs. This is far better than where we were. We need to be grateful to Papandreou for putting us here.

Better still, threatening Greece has allowed Merkel and Sarkozy to show some real steel, to belie their image as slightly muddled consensus politicians who can’t get in front of a crisis. Right now, they look a little more like the ruthless bastards they are going to have to be to deal with the remaining Greeks, and then Italy, and get us out of this mess. Baruch is allowing himself to feel something akin to a deeply unfashionable optimism. Greece is still a political basket case, terribly divided and mistrustful of itself, and possibly ungovernable in many ways. A lot of stuff can go wrong still. But nevertheless I think there is at least a possibility that the tide is turning slowly on the Euro, that when we look back this referendum battle will have been the El Alamein of the sovereign debt crisis, after which things will still ebb and flow, and dark moments fill us with panic, but the overall trend will be towards the light, and recovery.

As a long-time owner of (a very small chunk of) Apple stock, the past decade has been an absolute pleasure, with Jobs et al reïmagining and then dominating a whole run of product categories with apparent ease — music players, mobile phones, tablets, and now ultralight laptops. But in this success lies the seed of a problem: While the empire that is Apple has plenty of expansion left in new geographic markets and within existing product categories, Apple is exhausting the universe of gadgets it can colonize. I now have an iPhone, iPad and MacBook Pro on me most times, and go running with an iPod Nano. My next laptop will be Air-ish. But what additional new thing can Apple sell me that I must have as soon as I see it?

Even if Apple never again introduces another revolutionary iDevice with concomitant new revenue stream, it will take some time before Apple’s growth trajectory retreats from the exponential to the merely geometric. With Steve Jobs gone from the helm, however, there’s the possibility that Tim Cook will get the blame for this shift; when in fact all the low-hanging fruit has now been picked.

Yes, it has. All the product categories Apple has revolutionized have long been on the radar screen. Microsoft tried and failed to kickstart tablet computers during much of the naughties. Apple’s Newton was ahead of its time. Walkman music players were poised to be replaced by something digital. Laptops have since the start been massive compromises between weight, power, and battery life.

What might Apple do next? Television has been mooted as a candidate; the self-described AppleTV “hobby” has been a modest success, and there are rumors that Apple might use its lessons to try to properly reïmagine home entertainment using what it has learned from AppleTV. We’re halfway there with Airplay, which streams sound and video between wifi-connected gadgets around the house, but it is not yet seamless. (I’m an early adopter of it). If it becomes seamless, and stays much cheaper than competing Sonos’ systems, and the AppleTV OS turns into something of a platform that multimedia content providers can build apps for and stream content to, then we may have a proper new product category for Apple to dominate. Price here would be crucial, but that is something which Apple’s fabled manufacturing prowess could trounce the competition on, not least when it comes to screens.

And beyond that? Where else could Apple inject itself into my daily use of technological tools to be creative or to consume others’ creativity? Might it take on premium camera manufacturers like Nikon and Canon? Revolutionize (electric) car design? Develop connected appliances such as fridges that scan and refill themselves using the web? Jonathan Ive may well be chomping at the bit to bring Apple design to any of these areas, but somehow I doubt it can happen. Nikon and Canon already produce finely honed ergonomic masterpieces that are too niched for Apple; electric cars would be too large an adventure beyond its core competency, and while a connected intelligent home surely lies somewhere in our future, it is about as useful to speculate about this as to wonder when we’ll all be installing fusion reactors in our cellars (and what role Apple would play in their design.)

A more subtle worry of mine is that Apple will continue to produce gadgets and software that encourage content ownership, despite the fact that for the upcoming generation, “purchasing” digital content is increasingly anachronistic. Apple risks losing relevance among this group if it does not adapt, and it shows no signs of doing so (yet) despite the fact that the technology for alternate forms of paid consumption is mature.

My anecdotal evidence: As a resident of Sweden (which lives perpetually a little in the future) I have been using Spotify for several years. That Swedish start-up lets me legally stream and even download any music I choose from an iTunes-store sized library for a flat monthly fee. The service is social, mobile, and has become ubiquitous in Sweden; since signing up, I have not bought a single song on iTunes. Nor do I know any Swede who has (I asked again at a dinner party last night.) I’m sure that Apple’s internal iTunes store statistics for Sweden reflect this change on the aggregate level. And now Spotify has just launched in the US.

Movie rentals in iTunes are not the future either; the Netflix model is.

So these are the fears I hold for Apple in quieter moments. Emphatically, Windows 8 is not among them — the hardware is just as important as the software, and Apple, uniquely, is strong in both. I do see a danger of Apple making ill-advised concessions to Chinese censors for its future devices and cloud services sold domestically (it already did so with the Chinese iPhone 4), but the resulting negative publicity would not have an effect on the bottom line.

Of course, $76 billion in cash buys a lot of insurance against technological riptides. Baruch, what product category do you think Apple should colonize next? (I would certainly love it if Apple reïmagined driving. They could buy Volkswagen-Audi AG (market cap conveniently $63 billion) and soon thereafter announced the beautifully designed all-electric iAud. Considering that Google is already working on autonomous electric cars, surely that raises the odds of this happening?)

in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat  was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).

The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.

Pointing to potentially horrible unknown unknowns tends to capture the imagination much less than pointing to the definitely unpleasant known knowns of an imminent economic slowdown. The QE2ers’ argument at its core was the eternal and seductive call that Something Must Be Done. No less than James Suroweicki at the New Yorker picked up Baruch’s idea of the “undead homicidal zombie market”, tautology and all, and lumping me in with the Tea Partiers, House Republicans and the other dead-end no-brained foes of QE, labelled us  ”hysterical”. Baruch loves the New Yorker, but knowing their editorial stance and lack of track record when it comes to advising macro funds and governments, Baruch concluded their love of QE was less a well-thought-out economic analysis, and more a gleeful response to finding their political foes against an idea that felt “right”, Colbert-like, in their gut. In his response, (Felix also had a good one) Baruch bemoaned the politicisation of monetary policy by anyone. This hasn’t got any better – having an (admittedly Texan) presidential candidate threatening the Chairman of the Federal Reserve with a tarrin’ and a featherin’ if he buys any more bonds doesn’t seem conducive to a mature conversation on the subject.

So, was Baruch right? Or were the Suroweickians? An interesting thought experiment would be to think of where we would be without that second round of easing. With the benefit of hindsight I’m inclined to think we would have been better off right now had we not done QE2. Why?

•  back then, when the decision to ease was taken, we were clearly heading for an imminent global recession, which we didn’t have. However, we are undeniably there again, except we are also likely to have it accompanied by a sovereign credit crisis. It’s unlikely that counterfactual recession, had it taken place, would have been the short, sharp, devastating shock we got in 2008-2009 – the “V” shape; rather it would likely have been a more considered, drawn out process — a “U” shape — which would eventually have led to some sort of natural bottom. Whether we would be at that bottom now, 1 year later, is debatable. But we would certainly be closer to it, as opposed to now, just about to start our tribulations, with the blessed relief of the inevitable upswing much farther ahead of us and all the pain still to come.
• without QE2 we would have higher US unemployment right now, and an increase in the numbers of long term unemployed, a great evil. This is true. But we can’t say we have avoided this outcome either, merely postponed it. More than that, as I argue below, by QE2-ing prematurely we have much less room to respond to future, unemployment-creating shocks, making more long term unemployment more likely.
• we were heading into a proper bear market in stocks and a bull market in bonds when QE2 was initiated. Without it, we would not have had the rally in stocks in late 2010 and early 2011. The lower wealth effect would have intensified the fall into recession. However, again, this is likely still to come. Frankly I would have preferred this to be behind us, too. Also, by creating apparent demand that wasn’t real QE2 may have made any fundamental correction more painful by adding a further inventory component.

A fair criticism at this point would be that, fine, quantitative easing doesn’t appear to have worked, but it might have. It did no harm that would not have happened anyway, and postponing it was worthwhile enough; who knows, something could have happened. Given the imminent economic danger, it was worth a try, and as Suroweicki wrote at the time, it looked like “doing nothing would be doing damage.” In retrospect, however, it looks like there have been 2 important negative outcomes of QE2, one an ”intended” consequence, or at least a cost that was clear at the time, the other a consequence that was definitely unintended.

What was clear back then is that the Fed was going to be firing all its ammo — or to mix my metaphors, after QE2 it was going to have a lot less room for manoeuvre. Even if we are going to get QE3 we probably need a decent interval before we can do so, if only to maintain the figleaf that QE is not a permanent condition for the West having an apparently normal (read “zombie”) economy. In that interval a lot of bad stuff can happen, and the remaining unconventional tools the Fed still has in its box are looking, frankly, more Pythonesque than anything else; Operation Twist has apparently been tried before, (HT Kid Dynamite via AR) and didn’t work then, either.

I haven’t heard anyone use the words “money illusion” in a long time. I don’t know why that is, but I fear it is my age; that concept used to be a staple of my macro economics classes in the early 1990s, the then-consensus being from data in the 1970s and 1980s that while there may be some money illusion (“oh look there’s an extra zero on my paycheck dear, let’s buy that new LCD TV”) at the start of a period of expansionary monetary policy, over time it fades and the policy loses traction. We weren’t all Keynsians then. My fear is that the inevitable short term lift to the market from future QEs will be a disappointment. As far as QE2 went, it may have been better to wait — pump priming is best when there is actual water in the well. When it is draining out of the bottom, you’re just throwing what you had left away.

The second, less intended, and more insidious consequence of this great experiment, is that QE2 may have had an impact on the one part of the global economy that didn’t need saving: China. Baruch isn’t sure he understands exactly how Chinese monetary policy works (and neither is anyone else, it seems, which is why it has been under-reported), but something happened recently with capital requirements for Chinese banks that seems to be biting harder than that which has gone before. Baruch spends a lot of time with his ear to the ground on what happens to his stocks in China, and there’s been some funny checks of late — lower PC sales to businesses, sales of air conditioners not being what they were, etc, all apparently driven by a widespread inability to secure finance. The argument here is that QE spiked nominal commodity prices and made what was already a problem in China, high domestic inflation, significantly worse, turning it into people’s enemy number one. Baruch has little time for China bears and reckons economic growth there is real and good. So he would be very disappointed were there to be a hiccup or worse in China as a result of a failed round of QE. The only consolation is that there’s likely to be so much fucked up shit going in Europe when it does happen that we’re likely not to notice.

With hindsight then, the balance of the ledger doesn’t look good for the QE2ers and Suroweicki; it looks like we merely postponed a double dip, so that it lies in our future not in our past, and made sure there is much less US monetary policy can do to help when the time comes that the economy may actually be susceptible to unconventional easing. More than that, we may have screwed the only part of the global economy which was capable of hauling us out of our problems the old fashioned way, by real wealth creation. How’s that for “hysterical”?

This might be the occasion to have another go at it.

Contra the more sanguine amongst us, Baruch is more worried about the macro than he has been for a while. At times before he has always had a sense of why the bears can be wrong, be it China consumer growth,  a housing-financed consumer boom, Quantitative Queasing, a new product cycle in technology – even if he hasn’t actually believed it himself, he can see how others could, and frankly that’s all it takes sometimes. This time around the bulls’ cupboard seems a bit bare, and this monumental debt-deleveraging thesis the perma bears have been clarting on about all this time seems, frankly, to be one of the best explanations around to explain what’s going to happen to us all.

In fact the ONLY problem with the bear thesis here is that it seems too easy, too based on an analogue of 2008, in my mind, to be probable. Not that the analogue is unconvincing. Like now, the summer of 2008 was also a time of signs and portents outside the action in debt markets (now sovereign, then subprime), if you were watching closely. High multiple stocks and semiconductor companies and their suppliers were quietly blowing up. Baruch’s stocks started giving way later in the summer slow season (which is where we are now) subsequently rallied briefly, then totally collapsed with the rest of the market in September and October post Lehman.

In Baruch’s experience history is a bad guide; there’s always something different the next time around. Ask the French about the Maginot Line. This crisis will likely be better or worse than the last one, in different ways.

So anyway, this is Baruch’s current internal dialogue:

• OMFG we are so screwed! It’s just like 2008 again. I’m going to stick my head in the oven, even if it’s electric. It’s like all those newsletter writers say, we’re groaning under the weight of a massive debt burden which will take a generation of low, no or negative growth to get rid of. You seen Tracy Alloway’s AAA rated debt chart?! This isn’t the banks going under, it’s the people who bail out the banks, and once they’re gone the banks will go anyway. It’s an order of magnitude worse.
• Chill baby. One word: Policy Response. We’re used to this now, and we know how it ends. No one’s dumb enough to let Lehmans happen again on their watch. The Single Market and the Euro are not just the most important economic policy initiative of Europe’s governments, they’re also the most important part of their national security and foreign policies. They’re not going to let that go without a fight. The ECB is there to defend the Euro, and when that’s finally under threat they’re going to step up, or they won’t have jobs. And ultimately, Bernanke’s got our backs — after a decent pause we can have another dose of QE, and I have to say I enjoyed the last one a lot!
• Wise up, dude. Fiscal is blown up. S&P and the Tea Baggers, whatever they’re called,  seen to that. Don’t expect the Germans to get their wallets out any time soon either, they’re probably enjoying themselves too much, lecturing Southerners about Teutonic probity, and selling Euro-denominated Mercedes Benzes to Chinese people who can’t believe how cheap these things have become. Monetary’s all we got, Trichet’s heart isn’t in it and the operative clause with Bernanke is “decent pause”. The only thing scarier than not having QE3 in this environment is getting QE3 straight after QE2! What would that say about the state of the economy? Homicidal Zombie market eating your brains. Another good word would be “Money Illusion”, no? Bernanke’s got to wait, maybe until Q1 next year if he’s going to be in time for Obama’s re-election. And sufficient damage can be done within that “decent pause” to make last week seem par for the course. As TRB Josh puts it ,”think 1938, not 2008.”
• What’s wrong with you? You LIKE being miserable? You’re like one of those dinner party bores, oh so wise about how terrible the state of the world is, so wise he kept his portfolio in cash after selling out in January 2009. Last week is just normal seasonality, admittedly a bit spicier than usual, but exactly what you expect in the summer after the Q2 results. And each time there’s some flipping moaning Minnie going on with your “oh we’re all doomed”. We’re down not even 10% from an 11-year peak – 11 year! — in the NASDAQ, and you’re saying that was it, it’s over? You got no basis for that yet. Important parts of the world are growing great, consumer spend in the US doesn’t seem too bad so far either – you seen Mastercard’s result the other day? – and so what, some spreads widened? When the US was going to get downgraded on Friday everyone went and BOUGHT 10 year Treasuries! You have to rethink your definition of a crisis; you’re traumatised, jumping at shadows. Nothing really bad has happened yet!
• Oh man, are you complacent. When they bought them they were freaking out that there was going to be a recession. The fact they had to buy bonds that they know are going to be downgraded shows how screwed we are!
• You’re an idiot. Go over-intellectualise and wallow in misfortune. Me, I’m getting me some stocks.

Anyway, that’s as far as Baruch can go. Where are you at?

The thesis that one dominant platform wins the mobile “war” is naive.  . . Developers already understand this. Platform vendors know this. It’s time to unlearn the lessons of the PC era.

Evidence for this? Microsoft Windows Mobile platform apps are growing at a percentage growth rate that is faster than WM users grow, who collectively make up so little of the pie of smartphone users that the slice representing them would be mostly invisible. It’s not getting any better. WM activation rates are 1/28 of that of Android smartphones. The platform is continuing to lose share with subscribers yet, strangely, still seems to be gaining relative share in apps.

What appears responsible for this is the previously unheard-of ease of transferring apps from one platform to another, software tools such as Microsoft’s that allow the rapid creation of new apps and their adaptation for different operating systems, and an economic system that is set up to make writing software for mobile applications a “cottage industry” with a thousand points of light, rather than an industrial enterprise with 2 or 3 dominant players. The marginal cost of creating apps and sharing them between platforms seems to be very low indeed.  So why not make or adapt apps for Windows Mobile? You never know, it might come back. Mango, the new version which will be Nokia v.2′s adopted OS, might be the Apple or Android killer Microsoft hopes it will be.

If the ability to run the largest number of apps determines success then, far from being a returns to scale market like the one for PCs, the implication is that the market for smartphone platforms will be fluid, with nothing written in stone. There will be room for their relative shares to ebb and flow, variously dominating, fading and coming back repurposed for the new new thing in mobile computing: on this reading, it will be something like the game console market today, where 3 viable platforms survive.

What this means in its most practical sense is that there is hope for the platforms falling behind now, such as HP’s WebOS, RIM, and for OEMs like Nokia, for whom Mango is the only game in town. The implications for stocks are major. The option value in RIMM and Nokia would be much much higher than current share prices imply. This would make a lot of people who are short these stocks very unhappy.*

Comfortingly for them, however, there are equally compelling arguments that mobile computing will end up more like the PC industry than anything else. Firstly I suspect that, contra Horace, the profusion of WM apps has more to do with the sponsorship of Microsoft and its deep pockets than a sudden developer interest in championing losing platforms.  Secondly, its not just developers who decide who wins; operators remain in the mix. Their atavistc promotions and subsidy policies can also determine which platform sells. Don’t forget, moreover, that O/Ses are free! Android makes it so you can’t underprice zero to gain market share for your new platform. That helps to freeze things in place and mitigate against fluidity.

But most of all, the apps game remains secondary to the real goal of platform competition. The aim of the game, the whole schlemiel, remains to sell hardware, not software. Apple’s app store revenue is negligible in comparison to their hardware revenues, and will be for some time to come, at least until Apple finds a way to persuade people to buy higher ASP apps. Frequent purchase of 90c apps won’t move the needle against a $600-$900 hardware sale, even if everyone buys Angry Birds (and they probably already have). Until the dynamics of the mobile computing market stop being hardware heavy,  platforms are still vulnerable to hardware death spirals of the sort we’re seeing in RIMM and Nokia right now, where scale returns and operational leverage go into reverse

Don’t think either that just because is easier to write apps for a platform it is going to make it break out. The fact is that if all apps were available on all platforms rather than freeing up competition it would be likely to freeze the status quo in hardware into place. What killer app can Microsoft’s Mango offer me that I can’t get on my iPhone? What could possibly make me change my Android phone? A more functional OS? Better hardware at a cheaper price? Possibly. More likely that in the absence of anything significantly better than what I have currently I won’t change at all. Ecosystems are grabbing territory now that it will be hard to dislodge them from.

The dream of a fluid ecosystem for mobile computing is nice, especially for software developers tired of being the bitches of the hardware dudes. But it looks far off still. Mobile looks subject to the same laws that have governed tech markets throughout  history. That law is: no second chances. Value investing in consumer or enterprise tech very very rarely works. This is the key message for those who read Baruch’s last post and have fired their retail brokers and dumped their index funds, and who may be tempted to go off any buy RIMM at a 5x PE (don’t let me stop you, but do let me help you think before you do it)**. The graveyard of history is littered with those names that didn’t come back. For those that did, such as IBM, and indeed Apple, we forget just how low the low point was, and how wrenching it was to do the right thing so as to eventually re-emerge.

* you may think that this group of people includes Baruch. You may think that if you wish. But I couldn’t possibly comment.

** as I have said before, if you take anything you read on a blog written by an anonymous author as actionable investment advice, you may not be too bright. I can do nothing for you.

So let’s say it: I think the best thing for moderate net worth retail investors to consider right now is to take their retirement account back into their own hands. I think people should start to do some research with the aim of buying 3 to 5 single stocks, maybe just as an experiment. And if the experience is good, they can do it, and they gain expertise, they should make single stocks a big chunk, say 1/3 or more, of their retirement account in the next 10 years.

Not many people in the econoblogosphere and beyond will tell you that this is a good thing to do, not least because in many cases it is them and their ilk you have been outsourcing it to all these years.* Even those who don’t have an axe to grind  will likely be mildly horrified by such advice. Take Felix; a couple months ago he wrote:

we don’t want . . . a world where most companies are owned by a small group of global plutocrats, living off the labor of the rest of us. Much better that as many Americans as possible share in the prosperity of the country as a whole by being able to invest in the stock market.

Right on, Felix! And of course, the best way of guaranteeing this is surely by having Americans (why only Americans?) invest directly in stocks!

Well actually no. Felix hurries to reassure us in his very next line

I’m not saying that individual investors should go out and start picking individual stocks.

Felix is clearly aware where his train of thought is leading, and is keen to retain his position as a prominent econo-blogger who is taken seriously. Telling people to pick individual stocks, however, is clearly the path to ridicule.

For a more concrete list of conventional wisdom on the main reasons not to own stocks look no further than this post by James Altucher, which is misconceived on so many levels it is hard to know where to start, but makes up for this by at least being entertaining.

Let us pity the mid size retail investor — the ones with enough capital that it matters, but not enough to get access to pre IPO Facebook stock.  They are the battery hens of the financial service industry, on the receiving end of the least bespoke and the most exploitative service available. These guys get a lot of advice, much of it worthless, and all of it conflicting; they are the key demographic for most of the for-money blogs, newsmedia, and the Old Man newsletters (as Josh at TRB puts it so well). If you are one of this accursed, confounded and confused group, a forgiveable reaction is to put your fate in the hands of a retail broker at e.g. Merrill Lynch or UBS. Knowing your luck, you’ll end up in a range of very reasonable sounding knock-in/knock out structured products you barely understand. They’ll have you picking up the nickels in front of the steamrollers that catch up with us every 5 to 10 years, charging a hidden 2% load for the privilege of eventually blowing you up.

The gift of Peter Lynch, if you play your cards right, if you make the right mental breakthroughs, is that you can leave all the babble behind. With practice and dedication, and a supreme act of will, you can tune it out and make it irrelevant. The main reason very few people will urge you to do this is that there is not a lot of money in it for them and you may stop reading their blog. Taking charge of one’s own investment future, if you can, is simply much more rational than handing it over to the mishmash of conflicting incentives that is the financial services industry. It’s not unthinkable; it’s the logical thing to do!

It is not true that individual investors are always going to lose when they enter a stockmarket dominated by sophisticated insitutional investors like, well, like me. I have a huge disadvantage stopping me from doing the right thing; timeframe. I have a boss breathing down my neck to whom I have to justify my bigger trades as well as my weekly, monthly, quarterly and annual returns. I have a liquidity constraint. Some of the most interesting ideas can’t make it in my fund if there is not enough daily volume to take a meaningful position. I cannot “dollar cost average”. My investors like to invest more at the top of the market, and panic at the bottoms. I have to be largely fully invested at all times, and I have to spread my genius over a diversified portfolio of 30-80 stocks. I have to avoid market strife and drawdowns. I cannot embrace declines in the way that I should. I have to watch every twitch of the market. I have to worry about things like the VIX.

You don’t! Really. You can really be a long term investor and you won’t ever have to know what the VIX is. You can make it easy for yourself. Buying stocks is lucrative, and quite often even fun. Believe it or not, in the dim and distant past, normal people used to do it all the time! What really put the kibosh on it was the 1999 bubble and the lost decade for stocks. Before that, “buy and hold” was not as it is now considered a filthy and dangerous practice, like trying to indecently molest a cheetah. Rather it was the key way to create value in retirement accounts over time and a hobby for investment clubs across the developed world.

Peter Lynch’s 3 great insights are these: i) everyone knows about something, ii) only buy what you know. and iii) you absolutely have do the work. This means above all don’t buy hype or listen to stock tips in areas you are unfamiliar with. Don’t buy “cloud” stocks unless you are a software engineer. Only buy the latest genetic sequencing concept stock if you are geneticist or terribly interested in genetics. If you are a dentist, you actually have a edge over me when it comes to the long term trends in the dental implant business. If you are a plumber , you will know about, I don’t know, new types of pipe or something; or suppliers who have improved their pipes and are winning back market share. In his books, Peter Lynch talks about how much he loved retail. He famously used to grill his kids and his wife on what they were buying, and would visit shopping malls with them to get ideas. That got him into huge gains in stocks like Hanes, the owners of L’Eggs, and The Body Shop.

Instead of buying sexy stocks, penny stocks, or the “next big thing”, he urged, we should buy boring and safe. Even better, stocks which are faintly disgusting, like waste management stocks, gravel pits, or rat breeders. Stocks with an excess of “K”s in their names, like Safety Kleen, stocks which were ignored by Wall Street analysts, were the ones he wanted to buy. Baruch has found this to be true in his career, too. His greatest winners have been stocks where there was no analyst coverage (at least in English), which no-one had heard of.

Lynch is also very clear that it isn’t enough to just think of cool trends before going off to buy the stocks exposed to them. That is just the start of the process. To do this properly, and make money, there is also a lot of work involved, looking at balance sheets, finding out about valuation, making sure the PE divided by the EPS growth rate is not over 1, for instance. It demands a level of financial literacy that a lot of people don’t believe you are capable of. You’ll probably have to look at 15 stocks and probably more to find 3 you will like. This will take time. If you can’t spare it, don’t start. But if you are one of those people, like me, who take a month of cogitating and comparing peformance statistics before buying a new car, or can rattle of the RBIs (whatever that is) of 10 baseball players, you may have the mental resources, enough of an inner nerd, to have a go.

His books also make clear that a degree of “bottom” is also strictly necessary to do this properly. You need the independence of mind to dismiss fallacious arguments from impeccable sources; the courage to continue to invest, month over month, year over year, even after reading a John Maudlin newsletter; and the mindset that welcomes a big market selloff as the opportunity to buy some stocks really cheaply.

Your timeframe should be that of a Buffet. Not Steve Cohen’s, or mine. If you invest the same way as people like me you are doing it wrong. People like me will take you out to the woodshed and you will get, as my Oregonian friends charmingly put it, “stump broke”. In this Altucher is right. I turn over my portfolio well over 3x in a year. You should do less than 50%, probably 20%-30% is optimal. I think of a stock position in terms of weeks and months; you need to think in years. I check my portfolio obsessively every 5 minutes or so, and field calls about my core bets 2-3 times a day. You should check your stock prices once a week (or every month, if you can), and give each stock a check-up every six months or so. I might be out of a job in 12 months, and for me that is the long term. For your overall portfolio you need to think in units of 10 years (more on this later, I hope).

Of all the strange things I am urging people to do, this bit is maybe the hardest and where you are most likely to come unstuck. The entire financial media and most of the blogosphere is about this news cycle, who is doing well now, who is buying who, what the charts are saying, which sectors are hot and which are not. This is where the act of will comes in, the filtering, the wilful ignoring of most the facts, of the charts, and the blogs swirling around you. It is hard to make the mental breakthrough that in the long run the gross margin of Safety Kleen is more important to your portfolio than whether Greece defaults or not. And that if in fact Greece defaults and China rolls over and the world appears be at an end that people will still need to mop up grease spots or whatever it is that Safety Kleen does, and all that has happened is you now have a bargain price to buy more Safety Kleen with part of this month’s paycheck.

Above all, the key to success in investing is about taking responsibility for your investments. If things go wrong with your stock, it is not Bernanke’s fault. It is not your broker’s fault. It is not the fault of the guy who gave you the idea on his blog, or as part of his trading system, or the supposedly smart hedge fund manager who you read about who had it in his portfolio. It is yours. You did it. When you internalise this great truth, you will set yourself free. You will realise that you have as much right to an opinion as anyone else about something you have researched and thought hard about. And you will see that working hard to see a truth that others have ignored, putting skin in the game, and reaping the benefit of being right, is one of the great pleasures of life.

Right now we’re in a period of huge wealth creation in the most populous parts of the world, economies are more open and globalised than ever before, and we are blessed with stock valuations below the average of the last few decades. We had one of the worst crises ever and we came through it. Even Felix and Altucher are keen to point out just how much they like stocks as an asset class here. However, short term, things look a bit peaky and a decline may be imminent. The typical summer seasonality, and the approaching end of QE, are probably not going to help. If you’re not invested, this should be music to your ears. If you are, I shouldn’t worry. Overall though, I think now’s probably a good time to start investigating some stocks to buy in the next 3 to 6 months or so.

* this is also the case for Baruch, who should urge you to put all your money in certain sector funds, managed by him, but who won’t because really it is not a sensible proposition (although at least some won’t hurt you).

Felix uses the occasion of the takeover of the NYSE by Deutsche Börse to claim the US stockmarket has become somehow “irrelevant”. Far from being the “bedrock” of American capitalism, he writes, instead

the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money. . . a noisy sideshow that churns out increasingly meager returns.

Well.

Excuse me, but when any stockmarket not been full of speculators trying to outdo each other? Algobots are new, to be sure, but they don’t change the market’s essential nature, other than giving bad or unlucky traders another mealy mouthed excuse as to why they lost money. I think the great traders of stockmarket history, Jesse Livermore, Bernard Baruch and our own George Soros would be amused to be thought of as something other than speculators.

Yes, sometimes stocks can go up when economic growth is only so-so; the link between the two is indirect. Eventually they correlate, but the period when they don’t mesh can be pretty long. Increasingly though, as companies globalise, they reflect global economic growth. And you all have to get used to the fact that the US economy isn’t as relevant as it once was.

Sure, it might be that the number of listed companies has fallen. Baruch hasn’t counted. But so what if there are fewer? Is that bad? I would imagine that after a period of prolonged weakness, such as we have come through, when IPOs were hard and bankruptcies and mergers common, the number of listed entities would fall. It’s a bit like speciation in biology; every now and then we get Cambrian-like explosions, and periods of higher extinction levels. Let’s not draw conclusions from low samples. And anecdotally it is simply not true that there are no IPOs out there, and no small IPOs. Baruch has been positively plagued with them in the past 12 months, from second rate brokers pushing illiquid crap I wouldn’t go near with my worst enemy’s money, to once in a lifetime opportunities the Goldmans and Morgans have to beat the investors off with sticks. There was a great one the other day, and Baruch would love to tell you about it. But he won’t.

Where Felix is right is when he says that there are lots of interesting companies out there who don’t want to go public; its a complete pain, having to explain yourself to people like me. There are certain things about how investors think, their collective expectations, the behaviours they force companies into, that make Baruch’s toes curl. But there is one very important reason for going public which still proves, ultimately, irresistible to entrepreneurs, and it is this: it’s the only way to pay yourself and your people stock options. It is still the easiest way of making a lot of people very rich, and keeping them rich.

And ultimately whether Facebook goes public or not won’t change the central importance of stockmarkets. They are still the cockpit where it all happens, where the key society-shaping corporate entities of our time, such as Apple and Google, keep score against each other and their competitors. The power of a massive market cap doesn’t necessarily get used in all-stock M&A or when it raises money; it is a latent power, it is potential financial energy, which you don’t want to waste. You typically don’t want to use your equity to raise money as it dilutes you. But your stockmarket valuation sure as hell counts when and if someone wants to buy you.

Does the stockmarket allocate capital as efficiently as it used to? I have no idea, but frankly if you think you know better than the stockmarket how to allocate capital in a complex economy, I suggest you get back in your time machine and return to the 1970s to see how well that worked out last time.

I think far from being irrelevant, stocks are the asset class of the future; we had the years where bonds ruled in the noughties, and it ended badly. The Asian countries which are leading global growth now are debt averse, and their main focus is on their own equity markets which are getting almost as important, and just as liquid and vibrant, as the NYSE, with world leading companies like TSMC, Samsung, and Infosys trading billions of dollars on their local exchanges every day. Meantime, this is Baruch’s advice: stop worrying, and go buy an actively-managed mutual fund or go research a selection of stocks in spaces you know about, with the aim of holding them for a few years. Make sure that at least some of them are listed in a different country (but you can still buy the ADRs). Try not to listen to brokers. Keep reading Felix’s blog, though.

It was most obvious when F5 blew up in late January. The print was merely in line, and the guidance, sin of sins, was weak. FFIV opened down 20% and stayed down. This sort of move off a quarter can happen in tech, and is not at all uncommon. What was vaguely unusual, however, was  the extent of the surprise: there was no warning. The company had made no hints it had seen any weakness, and none of the analysts covering it had done the usual checks with their sources. Worse, no-one really knew what everyone else was expecting. There were no “whisper” numbers out there. Frightened of being accused of insider trading , no one had done the work.

Up until recently, there was a fairly clear procedure ahead of the quarterly report of a company like F5. At or near quarter end, sell side guys would call a bunch of resellers and ask how business was shaping up. C-suite guys, or guys in the finance dept. who actually knew the full numbers and could go to prison, would typically not be involved. So the data would be partial, and sometimes downright misleading, but would often have some truth to it. Based on that, the analysts would publish a preview, say something like “F5′s Q4 is shaping up well”, or “F5 may just come in line”, maybe fine tune their estimates, and call round their clients. The stock would move.

The good thing was, the quarter had now become slightly less of a random event. Clients would also give the sell side dude feedback on what they were looking for, and eventually those who were interested would have a whisper number, the real yardstick by which the quarter would be judged by, a number more realistic than the typically low-balled formal estimates. If the company was having a crap quarter, this whole process could cushion the bad news when it hit on the day. Of course, things would still go wrong and the stock would still cary what we call “gap risk” on the print, but in general, things were smoother. This went on for years, and the SEC (one assumes) knew all about it.

This time around, none of the above happened because it was no longer clear whether this was OK or not. Moreover, due to Reg FD, put in place about 12 years ago, management is unable to say anything substantive about current trading outside the quarterly report, unless in the form of a public profit warning or pre-announcement. Without being able to learn anything concrete from meeting managenent,  investors just had what analysts call their “body language” to go on.

Now I don’t know how many of you ever hang out with the CEOs of listed companies, but unless their world is falling apart and they are at that very moment being eaten by a bunch of hungry pigs, the body language of CEOs is always extremely “upbeat”. The white-toothed, well tanned, can-do optimism you see on CNBC is what you get in person. In CEO-world everything is for the best, in this, the best of all possible worlds. Major problems are invariably mere bagatelles, teething issues. Product flaws are features we didn’t know we wanted. Revenues aren’t going down; all that’s happening is that “sales cycles are lengthening”. F5′s C-suite had gone around the houses visiting investors (Baruch saw them as well) and had said that overall the prospects of the business were as good as ever, hiring was strong, and lots of super new products were coming.

All systems go, then. Upbeat management, gleeful analysts congratulating themselves on FFIV’s meteoric rise, armchair retail technologists discovering cloud computing for the first time, and a track record of spectacular “beat and raises” in the last few quarters, were the only ingredients going into the mix. Nay-sayers were cowed, shorts were absent. Altogether, you’ll agree, classic ingredients for a spectacular, portfolio-shattering blow up if the numbers were light. And they were.

Now Baruch, and every finance professional with a brain, fears the SEC like a primitive tribesman fears an angry god. Be in no doubt: this is a Good Thing.  Baruch applauds the feds’ activities against the blatant (alleged) cheating of the Galleon guys and those company officers (allegedly) selling information on their own stocks to hedge funds by acting as “consultants”. Lock them up, fine by me. Baruch himself is one of their victims; it appears many of his competitors had a massively unfair advantage over him in the past few years. Wankers.

The idea that the SEC wants to stop people from doing proper equity research is also absurd. They know the markets would cease to function. However, it may be that they don’t mind being a little vague about what is or what isn’t allowed. The real world definition of what constitutes insider trading is very gray: look at Kid Dynamite’s agonising /HT Felix) over an insight gleaned in a job interview. The test du  jour for insider-dom– does your information comes from a source who has a likely fiduciary relationship with the stock you are trading — arguably could mean it is insider trading when you find out anything from a company supplier or partner that the company’s management doesn’t want you to know.

Taken to extremes, insider trading laws maximally interpreted imply that very little real-time information-based analysis can be done at all. Ultimately, all equity research  is aimed at finding insights which are both material (otherwise it would be meaningless) and at least relatively non-public (otherwise it would already be in the price). As a result, almost every research-based institution fears they are already, arguably, guilty, and if the SEC really wants to Get You, it doesn’t need much effort on their part. Hell, just the announcement that you are helping the feds with their enquiries is enough to seriously mess up your business; look at the guys at Level Global who had to close this week merely for being raided. They had $4bn! If they are innocent, it’s a terrible thing.

If the only way we are going to be able to analyse a stock is by parsing the press release from the company, we’re pretty screwed. We will not be in good hands. Since The Crisis, we have been trained to vilify banks and traders, and by extension the hedge fund managers who pull down the big bonuses. What we have forgotten is just how dangerous villains the CEOs and CFOs of big companies can be, and just how much the game is stacked in their favour. We remember Enron, Worldcom and Parmalat, but there are so many more cases just like them on a smaller scale. Hedge fund managers get big bonuses, sure, but they “earn” them by being lucky or taking risks. If it goes wrong they walk away with nothing, their franchises ruined. But the managers have somehow structured it so that they walk away with millions even if they’re completely useless. AMD’s CEO got fired by his board the other day, for a lack of strategic vision. AMD’s market share is at a historic low, and is generally falling behind its key peers, so it didn’t seem unfair. He got $100 million as a “thank you” parting gift! The merely mediocre make out like the bandits they generally are.*

If you think over-powerful investors trading with inside information is bad for the little guy, wait until you see what happens if company managements get a total monopoly over market-moving information. We’ll have an Enron every week.** The nature of the beast is that company managements will never, ever fess up to bad stuff until they really really have to. When they do, it is generally too late, and tends to come at the end of a massive run in the stock, after they have cashed in all their options.

It is a recipe for micro-bubbles, big rallies and spectacular blowups in single stocks, in other words, a world of gap risk. And if investors and analysts are too scared to call them out when it is really going wrong, it is going to be a very pretty kettle of fish indeed. It will hurt precisely the people the insider trading laws were set up to protect. Significantly more volatility will likely discourage small investors much more than the suspicion that someone knows more than they do (smart investors know someone always knows more than you do).

Anyway, Baruch is hopeful. I don’t think we’ll get to the very bad place; the good investors and analysts ultimately will start to analyse again like they used to, if only because they can’t resist. And things will be better, the SEC and FBI will have done their job and the blatant insider trading rings will either be gone or discouraged for a while. But things would more assuredly return to normal, and much faster, if the SEC defined for once exactly what sort of information is legal and which is not. Anyway, just a thought.

* Oh don’t get me started on this. Bad actor CEO/CFOs have so much more of a pernicous impact on the market than dodgy hedge funds. Half the time they can basically print what they want on a quarter. Except just ahead of when the next round of management stock options get struck, then things turn weirdly negative, only to snap back to normal when the damn things are priced. They smooth earnings all the time, pay themselves fantastic amounts in stock options, then spend shareholders’ money buying the options back at market price  to avoid the dilution their massive payoffs to themselves have wrought. However, maybe because most of their tricks are aimed at making shares go UP, not down, they are rarely prosecuted.

**James Suroweicki, please note this is a wilful exaggeration. We won’t literally have an Enron every week.

This is sobering, but points the way to how such draconian measures can be circumvented by those intent on accessing independent news: By not relying at all on terrestrial infrastructure such as cell towers and Internet cabling, falling back instead on direct satellite communications.

By necessity, this set-up reverts to a broadcast/receiver relationship, with international broadcasters like the BBC and Al Jazeera able to invest in satellite video phones as a back-up in case authorities turn off other means of broadcasting live. The Egyptian people, meanwhile, have ubiquitous access to satellite television — as anyone who’s been to Cairo can attest after just a brief glance across the rooftops:

Satellite dishes on Cairo rooftops.

There is no way to restrict the reception of such broadcasting — there is no way for Mubarak to prevent Egyptians from watching satellite broadcasts of Al Jazeera short of turning off the electricity. This fall-back on satellite reception is not something widely available in all countries. In China, for example, it is cable television that is ubiquitous, a terrestrial mode of communication, that can and is blacked out at will by the Chinese authorities — most recently whenever CNN broadcast news of Liu Xiaobo’s Nobel Peace Prize.

While I am sure that much of Egypt’s older cohorts are glued to their televisions tonight, I wonder if turning off the Internet and mobile telephony earlier today didn’t have an effect opposite to what Mubarak’s regime intended: Egypt’s urban youth, suddenly without their main means of diversion or entertainment, had only the streets to go to. For once, there was no Twitter or Facebook or YouTube to distract them. All that was left to do was to go out and vent their rage.

On the same topic, The Rational Walk (again hat tip AR) has a detailed discussion of the possible motivations for investors sharing ideas. Quoting someone called Whitey Tilson, it posits a few viz:

1) It helps clarify our thinking to put our investment thesis in writing, especially on complex and controversial positions . . . .

2) When it is widely known that we have a position in a particular stock, we often hear from other investors who share valuable information or analyses.

3) Invariably, some people have the polar opposite view of a particular stock and, in sharing it with us, they can help us identify things we might have missed in our analysis. . .

4) When we share our ideas, it creates reciprocity and others share their best ideas with us.

How admirable, you might think. How open minded, open handed and collegiate. Bravo, that man.

Bullshit, thought Baruch.

First off, reading an article about how interesting it is that many investors can own the same security at the same time has the equivalent impact as reading an article tha says sometimes many women are interested in buying and wearing the same clothes at the same time. It is merely another revelation of the bleeding obvious, like the Economist last week which said that stocks which have gone up a lot sometimes go up more.

As for the crowded trades argument, well, crowding in illiquid, systemically important securities using leverage can be dangerous (think subprime CDOs), but I don’t think the Fed should lose sleep if 20 big hedge funds are all long VISA. When that tanked I don’t think anyone other than Visa and Mastercard noticed. It certainly didn’t rock my world.

Let’s not be naive. When it comes to the reasons for sharing ideas, there’s really only one, and OK, maybe a second, lesser but linked, reason why investors share their ideas with each other. The first and only real reason is what we call “reverse broking”, the sole purpose of which  is to make our stocks go up. The lesser reason is that most hedge fund dudes love to show off to their peers. There’s nothing more satisfying than going to one of those dinners, clarting on about your favourite stock and seeing it pop 3% the next day on no news and knowing it was a whole bunch of supposedly intelligent investors copying you because, you think, they think you’re just great.

That’s basically it; the ancilliary benefits to the investment process mentioned by Mr Tilson may be real, but they aren’t even the icing on the cake — they’re maybe the Hundreds and Thousands.

Frankly, these 2 are the only reasons Baruch ever shares his wisdom on particular positions with his peers, be they brokers or fellow strugglers. And you can be as sure as sure can be that when he does so he has bought his full position.* That’s why Baruch smiled at this, from The Rational Walk again:

. . . when Mr. Tilson published his analysis of BP in June, he took the risk that the response may have pushed up BP’s share price which could have prevented him from building up his position as the shares continued to drop in the subsequent weeks.

Right. For him to NOT have a full position at the time he published his analysis would make me, were I an investor in his fund, very angry. How irresponsible, I would think. I’m not paying him 2 and 20 to strew his pearls of wisdom amongst the Great Unwashed for free!

No, Baruch loves his colleagues and competitors, but as he has written in the past, investing at a professional level is a solitary pursuit. You don’t show your work to others unless you have a good reason to. And when people DO share their ideas with you, you’ve got to be pretty uncharitable in your thinking about that as well, because their motivations may not be pure. When Whitney Tilson publishes his ideas as to why NFLX is a great short — after he has lost just a ton of money on it –  can you be sure he’s not just trying to engineer a quick drop in the shares to exit his position with a small shred of honour? Let me hasten to add, I don’t think Whitney Tilson is a bad actor in this way, but trusting the altruism of participants in financial markets is not a well-accepted path to riches.

* this is one of the many reasons that Baruch doesn’t us this blog to pump his stocks. He has too much respect for you, his dear reader, to do that. Note also that if you see anything on this blog which could be construed as positive or negative commentary on a particular stock, it is in no way investment advice. Also you should assume Baruch is long or short to the gills.

All well and good, and jolly interesting too. So much so that it was picked up by the WSJ, Paul Kedrosky, and of course, Tadas at AR.

Baruch certainly found the article interesting, as these were thoughts very similar to those he set down over one year ago in a blogpost here called What’s an export? Seriously. In it, after examining the supply chain of the iPhone* in some detail, he concluded that high tech products which are merely assembled in China distorted the picture. Very little of the value of the iPhone comes from, or remains in China, yet the full value of the iPhone is counted as a Chinese export for the purposes of deficit calculation. He wrote

Presumably to work out the real trade balance in terms of where trade flows, or where the wealth generated by iPhones goes, classifiying it as a {Chinese} export for the purposes of assessing a trade balance is misleading . . . Where there are totally integrated global supply chains, I suspect that the definitions of “import” and “export” begin to lose meaning.

Baruch was confused: why did economists and politicians harp on about the trade deficits like this when it  assessing the true value of the deficit was so obviously problematic? The post ended with a plea:

If there are any professional economists left reading UB, please help.

“Help” in this case, did not mean “purloin my idea and publish it in your own name for the glorification of your career without so much as citing poor old Baruch.”

What do you think Bento? Can I sue?

*happily, Xing and Detert also make a hash of the foodchain of the iPhone. Toshiba does NOT make the touchscreen and display module of the iPhone, though may be implicated in the NAND memory; touch module is left to an obscure-ish Taiwanese company called TPK, the screen could come from a whole passel of suppliers, but probably not Tosh; the apps processor is only “fabbed” by Samsung but is a design owned by Apple, Infineon does not make the “camera module”, though does make the baseband and some other stuff. Etc etc.

What’s most striking about the attacks on QE2 is how hysterical they are. People aren’t just suggesting that the Fed’s policy—which is quite modest relative to the size of the U.S. economy—might be ineffective or mildly inflationary. Instead, they’re accusing the Fed of “injecting high-grade monetary heroin” into the system, pursuing a policy that “eviscerates” the middle class, and potentially giving birth to an “undead homicidal zombie market.”

The main problem with this of course, is that this last bit never happened. No-one ever accused the Fed of potentially creating an undead homicidal zombie market.

What Baruch actually wrote (my emphasis) was:

“I’m not saying we’re in an undead homicidal zombie market,”

And there we could let it lie.

Although to be fair, I did add “though we may be” as quite frankly I was not very sure of anything at that particular moment. Communicating this lack of certainty was the point of the post, which was about feeling confused and worried. But nevertheless, in the offending line above, Baruch was trying to stop going too far down the path of a metaphorical flight of fancy about undead cats. To avoid, if you like, hysteria.

So James S. has it completely arsy-versy. Clearly he hadn’t actually read Baruch’s post, and by the way James, in the unlikely event you ever read this one, if you do choose to misquote me disapprovingly the least you could do would be to drop us a link, no? Probably you have an outdated editorial policy that prevents you from doing so, but still, this is the 21st century.

Calling one’s opponents “hysterical” is, moreover, quite a cheap rhetorical shot, a debating tactic much used by Straussian neo cons and WSJ op ed writers to close off a reasoned argument they are on the wrong side of. Different words that do the same job are “partisan”, and (Baruch’s favourite) “shrill”. If someone is hysterical it is much easier to ignore the points they make. Rather, the word implies, they just need a hard slap and a good shake. The word has the stench of politics about it.

That’s the wider context here, which I think we need to put James’ article into. QE2 has become politicised, and this is a mark of just how demented US political discourse has become. Domestic bond purchase programs elsewhere don’t generally create similar levels of controversy between parties; most politicians realise their central bankers are just following through with their mandates, as the Fed clearly is, without any regard for political advantage. Baruch thinks the blame for the politicisation lays squarely at the feet of congressional republicans. He also finds it highly amusing to find himself somehow lumped in with this lot, however indirectly, as he has yet to contemplate a more priceless, ill-intentioned, irresponsible and ignorant set of economic baboons.

But the worry is that if the republican baboons don’t like QE2, then it follows that those on the other side of the aisle will start to like it, not on the basis of a reasoned weighing up of pros and cons, rather because it gives them good talking points. The result will be the vaguely uncritical lumpen thinking we see in the New Yorker article, and at its worst, an item of pragmatic economic policy which should be debated on its merits will join the pantheon of topics of almost theological controversy in the US such as abortion, gun control, flag burning and gay marriage. Pretending that QE2 is a well established economic policy without risk of externalities is frankly as absurd as saying it is an unmitigated evil.

Felix, whose own position is not far from Baruch’s, does a much better job of tackling the article in this post. As he puts it, “the weird thing is that Surowiecki and I actually agree on most of the issues here.”

Indeed. As things stand right now, Baruch is very rapidly coming to terms with QE2: not particularly astonishingly, the thing might actually be working! There are green shoots everywhere he looks , from an apparent increase in volume at transaction processing companies, to semi makers guiding for much lower seasonality in the next quarter, to positive 2011 GDP revisions by the economists, to strategists telling me to buy cyclicals, etc etc. The price of gold even dropped a bit on thursday. He is pretty optimistic, certainly much more than he was last month, when his problem was that he could see the sufficient reasons for stocks to rise (QE2), but not the efficient ones (forward EPS estimates going up). That’s been solved, confusion lifted. Things are great!

Then again, that’s exactly what I’m supposed to feel, isn’t it? There’s nothing like turning up to a party with a hangover (swearing you’ll only stay for a bit), having that first drink and realising how much fun you’re going to have if you stick around. Thoughts of a potentially much worse hangover yet to come are far away.

So we have been having Quantitative Easing already, and Baruch doesn’t  like it.  The stockmarket is up (or was), the data seems to be improving; QE has done its work and for all we know it will continue. But there is a special unhealthy quality to it all. It feels like a “wrong” rally, like the cat from Pet Sematary was clearly a wrong kind of cat.

The problem as I see it is this: QE lowers overall interest rates and makes all the stocks go up when they wouldn’t have normally. It raises their valuations, which you can also express by saying it makes for higher PEs. This makes people feel richer. They will go and buy more stuff like LCD TVs, making the companies who make the stuff they buy richer too. They will invest more, and buy more stuff from companies who make stuff not for people, but for other companies. Eventually all the companies grow into their higher stock valuations, and we are all fine.

The key word here however, is “eventually”. What happens in the bit between the 2 points:  after all the stocks have gone up, and before the fundamentals improve to justify their new valuations? Because I think that’s where we are if stocks have stopped going up, or where we will soon be.

Now, my tech stocks aren’t exactly expensive. Lots of them are to be had for PE multiples in the low teens, which really isn’t bad. But there has been no fundamental improvement in their businesses since the summer, as far as Baruch can tell, and yet their stocks have absolutely zoomed to levels I frankly have difficulties buying them at, at least on the charts. Baruch was astonished last week to see that the NASDAQ 100 was basically back to its pre-crisis high!! You get that? That index is telling you that things are as good as they were before the Great Unwind.

I can’t short them either, at least not on past form. That’s been a mug’s game; the subtext of QE is “kill all the shorts” — another way of making sure stocks go up. Returns on short books have been pretty brutal, and most long short guys in the past couple of months have learned to be mostly long, or if they have to stay balanced, then long stocks, short indices.

So, now what? If stocks are now disassociated from their fundamental realities, however short a time that disassociation is supposed to last, non-fundamental realities are going to rule, and I have no idea what that means. Will we get stasis, a crunch in volatility and volumes? Will we have vast nauseating unexplainable swings in stocks, huge moves in the VIX? Will we crash? Will we carry on straight up? Will we pause and rally? Who can say? We’re in a period where anything is possible, as I’ve said before, a world of unintended consequences coming down the pipe. Some may be good, and some may be bad.

This is why in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat  was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).

The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.

I’m not saying we’re in an undead homicidal zombie market, though we may be. But here’s an example of what the Pet Sematary market is capable of in terms of unintended consequences: QE inflates all asset prices, including commodities. This pressures the Chinese consumer, who we are relying on to pull us all out of this mess, who can suddenly not afford his new LCD TV because his Moo Shu pork is costing 20% more than it used to. Changes in commodity prices have a much greater impact on his consumption than Joe Schmoe in Idaho, with his low cost high fructose corn syrup and processed trans fat diet. The BoC has to raise rates to offset the inflation this is causing, hurting Chinese growth even more, and global GDP growth drops 50bp. Bravo the Bernank. With your Quantitative Easing you just killed off the only good thing in this market which was working naturally without outside interference.

OK, Baruch may be exaggerating, but a big part of today’s selloff is driven by fears of commodity prices in China and a collapsing Shanghai stockmarket. It’ll probably turn out to be nothing, a damp squib. But if it doesn’t, you heard it here first. I feel sure there is a wider point here to make about the bad things that happen when you mess with the signalling mechanism of the stockmarket. After all, the stockmarket does not exist solely to make us richer, does it? But that’s probably for another post.