2018-01-18

Investing Cash in January 2018



I know a fellow who had two homes. He sold one of them to raise some cash. He’s now looking for a better house for him and his wife to move into. When he finds it, he will buy it, and sell the other house. He says he’s investing the pile of cash in bonds. Indeed, short term bonds or cash is the place to put a few tens or hundreds of thousands of dollars if you expect you will want to make a down payment on a house with it during the next two or three years. You will miss some of the higher yields available in stocks, but if the stock market crashes, short term bonds will retain nearly all of their value or maybe even increase in value a little, and you will still have your down payment.


S&P 500 Jan 18, 2007 to Jan 18, 2018

If you are buying bonds, remember that as interest rates rise, the value of a bond (especially a long term bond) will go down. These phenomena resemble two sides of the same coin. They are literally inseparable. So, if you’re stashing your cash in bonds, buy short term bonds, like VTIP Vanguard Short-Term Inflation-Protected Securities ETF, with 2.5 years average duration.

But if you have a longer time horizon, you might seek a suitable investment in real estate, on the theory that it might not crash so much if the stock market crashes, and might even go up. Now, that’s not a recommendation exactly, but a hypothesis. If you take that view and base your thoughtful speculation on it, then you have some good choices.

I'm currently aware of two ETFs of good quality invested in REIT indexes of many REITs so that they more nearly approximate the wisdom of a real estate index than the brilliant ideas of 3 or 4 analysts running an actively managed fund that the market can easily outperform. These have a good combination of book value to price, low expense ratio, high & consistent rate of dividend growth.


VNQI Vanguard ex-US Real Estate

SCHH Schwab US Real Estate

Some brokerages might well have their own indexed fund of REITs, probably with the promise of commission-free trades for their own products. However, with the commission on a trade being $5 (at Fidelity and Schwab, for example) for even fairly large (non-institutional) trades, the value of "commission-free" is among the most trivial things. Indeed $5 is overwhelmed by the expense ratio and the dividends paid and the price movements in the market. So, "commission-free" shouldn't guide your choice of investment.

Individual stocks necessarily have a deeper potential downside than REIT ETFs. They also have a more spectacular potential upside. Some stocks I'm aware of that we can expect to move with the general value of real estate include the following three.


DLR Digital Realty Trust, REIT specialized in Data Centers.

DHI D. R. Horton, House builder.

HHC Howard Hughes Corp., Large-Property Development & Management

HHC is rather more speculative, in my opinion. While the company has made a profit in only the last two reported years, the level of profit has increased monotonically during each of the last 4 reported years, suggesting they have learned to manage making profits consistently and at increasing levels.

DLR and DHI survived the last market crash. HHC didn't exist at that time. The S&P 500 peaked on Oct 9, 2007, then declined to bottom on Mar 9, 2009. I find it interesting to look at the change in price between these dates afterward to Mar 9, 2010.  DLR lost 32% of value, and DHI lost 47% of value from market peak to bottom, so that both performed better than the median stock during the decline. In the recovery from bottom to a year later, DLR increased by 97%, slightly above the median of 81% for stocks, & DHI by 70%. Overall, from peak in 2007 to the 2010 anniversary of the bottom, DLR increased in price by 34%, and DHI decreased by 9%. During the last 10 years, DLR increased in price by 200%, and DHI by 290%, both above average for stocks, and both have increased in price in 8 of the last 10 years, rather more consistently than all but 3% of stocks.

Regarding the resilience during the crash of 2007-9 and aftermath, there are two stocks that performed well during this period which I regard as good long term investments.

EBIX Ebix, insurance exchange software, increased 15% from Oct 9, 2007 to Mar 9, 2009 & 154% from Mar 9, 2009 to Mar 9, 2010.

PCLN Priceline, travel services, decreased 14% from Oct 9, 2007 to Mar 9, 2009 & 204% from Mar 9, 2009 to Mar 9, 2010.

All that said, There's nothing too foolish about buying the S&P 500 and never selling it. Crash or no crash, just hold on to it. Warren Buffett recommended that specific strategy for his heirs and further specifically the Vanguard S&P 500 fund (VOO on NYSE). See page 20 of his 2013 letter to shareholders 2013 letter to shareholders, or the short version in the news article from Mar 13, 2004 MarketWatch. The shares of Mr. Buffett's company Berkshire Hathaway sell for about $210 (BRK.B on NYSE). I regard BRK.B as a better long-term investment than 2/3 of stocks, provided you put just a small fraction of your life’s savings in it. In case of a crash, just hold on to it.

Disclosure: I own shares of SCHH, VNQI, VOO, EBIX, PCLN, and BRK.B.











2017-12-17

The Fairy Tale of Capitalism: Corporations, the Free Market and the Invisible Hand



“The first function of a mythology is to waken and maintain in the individual a sense of wonder and participation in the mystery of this finally inscrutable universe.” 
-- Joseph Campbell, quoted by Michael Toms in “An Open Life” (1988)




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James Lancaster VI, commander
of the first voyage of the
East India Company (1601) 
Long before the Old Ones, an ingenious new production organizing technology appeared. Elizabeth I of England chartered the first limited liability Corporation, a “company of merchants of London trading into the East Indies”, known as the East India Company. 125 shareholders contributed the initial 72,000 pounds of capital. The year was 1600.


The shareholders (a.k.a. stockholders) control a limited liability Corporation. The Corporation begins when the Corporation’s CFO Chief Financial Officer receives something of value, usually cash or an existing business, from the initial investors. The CFO gives them ownership shares, each share having same value. Each investor owns part of the corporation in proportion to the number of shares she owns. Almost simultaneously, the investors choose the CFO, the CEO Chief Executive Officer, who makes day-to-day decisions for the owners and manages employees, and a committee called the Board of Directors, which hires and fires the CxOs and decides questions for the owners.


The Corporation resembles a person, because it can autonomously conclude contracts, trade, incur debt, declare bankruptcy, and contribute to political campaigns.

"Limited liability company" means if the Corporation gets in trouble, then it’s the Corporation’s fault, not the shareholders’ fault. The shareholders bought their shares from the Corporation or on the Exchange. Their liability is limited to what they paid for their shares. Having already paid, they have no further liability.

East India Company Chop

If customers sue the Corporation for making a dangerous product, and the judge orders the Corporation to pay, then the shareholders pay nothing. If the Corporation borrows excessively and can't pay the debt, the Corporation pays what it can, and shareholders have no obligation.



That means shareholders aren’t responsible for the Corporation they own. That means the Corporation is a "moral hazard". That doesn't mean the Corporation is a bad thing. The big knives in your kitchen are physical hazards. They aren't bad things. You must be careful with knives and Corporations. But that’s another story.


Even before Elizabeth I, a Corporation was a more or less formal group of people, organized for some purpose, and empowered by law to act as an entity or person. The Old One Adam Smith described the economic role of trade guild corporations.  Since the Great Wars, "Corporation" has referred usually to business Corporations, organized by investors to dodge taxes and increase their personal wealth. In our modern Society, we use Corporations for the purpose of supplying many, perhaps most, of the goods we use.

The Corporation’s CEO outranks other Managers. If the Corporation’s profit usually increases somewhat from year to year, then the Staffs advise their Aristocrats to allow the CEO a free hand. And if the Corporation’s profit isn’t so good, then the Staffs usually sell their Aristocrats' shares, to avoid the excessive paperwork of dismissing the CEO. The remaining  apathetic and hopeful shareholders usually allow the CEO a free hand. Corporations owning Corporations and other ingenious legal elaborations of the art add further distance to the shareholders from the CEO. The authority of the CEO with a free hand grows perhaps so much that she chooses members of the Board. But that’s another story.



Certificate for Six shares of stock in a Corporation (1887)


In the Free Market, many buyers and many sellers compete. Any seller (or buyer), dissatisfied with a price (or product and price) offered by a buyer (or seller), can readily find another seller (or buyer) with whom to trade.


Adam Smith observed that, when we as buyers approach a seller in the Free Market,


"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves not to their humanity, but to their self-love ..."


The buyer gets the product, in exchange for the money she gives up.
The seller gets the money, in exchange for the product she gives up.
In the Free Market, each person gets what she wants more, in exchange for what she wants less. This is a public service distributing to all what they need.


Each buyer and seller, says Smith,


"... intends only his own gain; and he is in this, as in many other cases, led by an Invisible Hand to promote an end which was no part of his intention."


Smith also wrote that the Invisible Hand guides an employer to distribute the necessaries of life in roughly equal quantities to the employees by the natural cascade of the Downward Trickle, so each person gets an approximately even portion. But that is another story.

The Economists George Akerlof, Michael Spence and Joseph Stiglitz wrote of snakes in the garden of the Free Market: information asymmetries. The holder of a product knows better than others the quality of the product. The seller of the used car knows if the car is a low-quality "lemon" or a high-quality "peach". The prospective buyer, knowing less, discounts her offered price, to mitigate the inferior quality of a "lemon". But if the seller knows the car is a "peach" then she hesitates to reduce her price. The seller’s price exceeds the buyer’s price. So no trade occurs. Neither party benefits. Each trader benefits in a fair trade.



Market, Padua, Italy (1891)


When the CEO goes to the Free Market to hire Managers and Workers, information asymmetry accompanies each hire. The current employer knows the individual employee's ability well. The prospective employer discounts the wage offered the prospective employee, as Stiglitz says, "knowing that they will succeed in luring him away from his current employer only if they bid too much. If they bid less than his productivity, his current employer will match. Labor mobility is impeded."


And negative externalities inhabited the Free Market. When people of the same industry meet, even at parties and entertainments, wrote Adam Smith, “the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."


The Professors sang to their students: "The only purpose of a Corporation is to serve the interests of the stockholders!"


In our next episode of FTC, we will consider the curious relation among Capital, the Chairman, and the 50 Percent.




Several friends read and critiqued the pre-publication draft, for which I am most grateful.



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Images 


“Chicago, Burlington & Quincy Railroad Stock Certificate” (1887, Public Domain, https://commons.wikimedia.org/wiki/File:Chicago,_Burlington_%26_Quincy_Railroad_Stock_Certificate_1887.jpg)


The East India Company, “Chop” (17th Century, Fair Use, https://www.theeastindiacompany.com/wp-content/uploads/2016/08/EIC-Chop.jpg)


“James Lancaster VI” (1596, National Maritime Museum, Greenwich, England, Public Domain, https://pt.wikipedia.org/wiki/Ficheiro:Jameslancaster.jpg)

Paolo Salviati (1818-1894), “Palazzo della Ragione, Padua, Italy” (1891, Hallwyl Museum, Public Domain, https://commons.wikimedia.org/wiki/File:Fotografi_fr%C3%A5n_Padua,_Sala_della_Ragione_-_Hallwylska_museet_-_102990.tif)




Sources



George A. Akerlof & Robert J. Shiller, “Animal Spirits” (2009, Princeton University Press, http://amzn.to/2iar4Mz)

George A. Akerlof, “The Market for ‘Lemons’” (Aug 1970, The Quarterly Journal of Economics, http://www.unc.edu/~shanda/courses/plcy289/Akerlof_Market_for_Lemons.pdf)


Daniel Brockman, “The Eric Tetralogy: 2: The Tea Party” (Aug 29, 2017, https://daniel-brockman.blogspot.com/2017/08/FTC-eric-tetra-2-tea-party.html)


Daniel Brockman, “The Eric Tetralogy: 4: Ideas as Monops” (Aug 29, 2017,

https://daniel-brockman.blogspot.com/2017/09/FTC-eric-tetra-4-ideas-as-monops.html)

Daniel Brockman, "The Fairy Tale of Capitalism: CEOs, Growth and Prosperity of Society" (Mar 31, 2017, https://daniel-brockman.blogspot.com/2017/03/ftc-ceos-growth-prosperity-society.html)


Daniel Brockman, “The Fairy Tale of Capitalism: Managers, Professors and Engels” (Jun 12, 2017, https://daniel-brockman.blogspot.com/2017/06/ftc-managers-professors-engels.html)


Daniel Brockman, “The Fairy Tale of Capitalism: Rand, Marx and the Downward Trickle” (Nov 13, 2017,

https://daniel-brockman.blogspot.com/2017/11/FTC-rand-marx-downward-trickle.html)

Daniel Brockman, “The Fairy Tale of Capitalism: Supercompensation, Income and The Exchange” (Apr 6, 2017, https://daniel-brockman.blogspot.com/2017/04/ftc-supercompensation-income-the-exchange.html)


Daniel Brockman, “The Fairy Tale of Capitalism: Workers, GDP and Economists” (Mar 17, 2017, https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-workers.html)


The East India Company, “The East India Company’s Timeline” (http://www.theeastindiacompany.com/home/timeline/ retrieved Nov 18, 2017)


Adam Fresco, “With one eye firmly on the past, new chapter begins for East India Company" (Feb 8, 2010, The Times, London, https://www.thetimes.co.uk/article/with-one-eye-firmly-on-the-past-new-chapter-begins-for-east-india-company-6dmjkrdmwmr)


George E. Hoffer & Michael D. Pratt, “Used Vehicles, Lemons Markets, and Used Car Rules: Some Empirical Evidence” (1987, Journal of Consumer Policy, https://link.springer.com/article/10.1007%2FBF00411482)


Adam Smith, “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776, Public Domain, http://amzn.to/2jjusby)


Adam Smith, “Theory of Moral Sentiments” (1759, http://amzn.to/2Aq8wQL)


A. Michael Spence, “Signaling in Retrospect and the Informational Structure of Markets” (Prize Lecture, Dec 8, 2001, https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2001/spence-lecture.pdf)


Joseph E. Stiglitz, “Information and the Change in the Paradigm in Economics” (Prize Lecture, Dec 8, 2001, https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2001/stiglitz-lecture.pdf)


Michael Toms, "An Open Life" (1990, Harper Perennial, http://amzn.to/2Bz3Cnw)

2017-11-13

The Fairy Tale of Capitalism: Rand, Marx and the Downward Trickle



FTC the Fairy Tale of Capitalism is deeply, but inconsistently, sarcastic.




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 Once upon a time, ...

Ayn Rand, 1925, Public Domain

... economics described the behavior of people as observed by the Economists. The Economists included Old Ones David Ricardo and Adam Smith. They set their tales in scenes of the emergent industrial age and described human behavior for all time. Both were aware of the Downward Trickle, the waste stream of the Aristocracy, though neither of them named it that. The name arose in the time of Reagan as the Great Wars drew to a close, but that’s another story.


Smith wrote that the Invisible Hand guides the rich to divide necessities into equal parts for all.  Ricardo wrote that the capitalist employs Workers from the unemployed reserve to operate the highly productive machines of the new technologies. The capitalist pays wages of Labor to the Workers for their necessities of life, just enough to keep the Worker working for another week. When the business cycle flattened or turned down, as it did every 8 or 10 years, the employer capitalist dismissed the employee Worker, who would then join the unemployed reserve, receiving no wages, ready to work all day for bare necessities, and suffering privation. From this economic background emerged Karl Marx.


The Old One Karl Marx was a well educated newspaper editor, active in the hodgepodge of socialist political movements of post-Napoleonic Europe. He read Ricardo and Smith, understood them well, and didn’t dispute the main character of their descriptions.


Karl Marx, circa 1870, Public Domain
Marx and the Old One Engels met as young men and began a lifelong collaboration. Legend informs us they were dividing the bar bill with some anarchist friends in a Parisian bistro just after Christmas 1857, when Engels overheard one word which was the punchline of a joke, the word "capitalism".


Marx and Engels compiled factual detail of the Downward Trickle of wealth and income from the Ten Percent to the Workers. They saw chronic starvation among the Workers and their families, with some starving to death during business downturns. They said these deaths were the unavoidable consequence of private property. A minor political party commissioned them to write a mission statement, the "Manifesto of the Communist Party", in which the word “capitalism” appeared in print for the first time. The word “capitalism”, with the tranquility of a thunderbolt, cleaved modern governments into two parts.


Capitalism, wrote Marx and Engels, was the scientifically unavoidable result of private property. Communists opposed capitalism. Communists called for the abolition of private property beyond the modest house, garden, storefront and workshop of an ordinary household. The coercive powers of government defended capitalism, so that peaceful reform would never overcome capitalism. For Marx and Engels, Workers had no choice. Workers would rise imminently, unavoidably, inevitably in violent revolution to replace Capitalism with a new social structure featuring the control by the Workers over the means of production.


As you know, not uncommonly FTC uses a word with two different meanings. "Capitalism", named by Marx and synonymous in his work with "capitalist production" and "capitalist system", means the way a capitalist (person wealthy in private property) uses her capital (wealth in private property) to establish and operate a Firm with intent to increase her capital, employing Workers when necessary to operate the equipment. "Capitalism" also means a political view advocated by persons who favor the capitalist system, who may or may not have great wealth of their own. Perhaps you can easily imagine a capitalist of much private property would likely consider herself a capitalist of view, advocating for private property. Let's also remember that a poor person can be a capitalist of view, but can't be a capitalist of great wealth.


Skyline of New York City, circa 1950, Public Domain
Marx's christening capitalism stirred a shiver of alarm among the capitalists of wealth at the time. Though capitalists controlled the governments, socialists and other friends of communists successfully got legislation over the next decades to abolish child labor, to limit the hours of the workweek, to legalize labor unions, etc. Capitalists of wealth and their allies self-identified as capitalists of view and organized to preserve private property and to prevent impairment of profits.


A century after Marx's midwifery of capitalism, during the Great Wars, Ayn Rand emerged to write gigantic novels and host an intellectual salon of capitalists of view in Manhattan. She gave the most lucid defense of capitalism. She sang like a Professor, but she was not one. She was not an Old One, nor an Economist, but she wrote long unintelligible tales. Like Jeanne d’Arc, she evades classification.


Rand claimed virtuous selfishness was objective and rational with the same superstition that Marx claimed communist revolution was scientific and inevitable. Rand conflated Stalinist and Maoist tyrannies with communism and socialism. Stalin and Mao were dictators. Stalin and Mao were socialists and communists. Therefore, all socialists and communists are dictators, so her reasoning went.


Rand said private property was necessary for human rights. Marx said the 90 Percent had no rights, and that only the Ten Percent (whom he most frequently called the "bourgeoisie"), the possessors of capital (which he called "bourgeois property"), enjoyed rights.


Marx said capitalism had produced wonders of production far surpassing the Egyptian pyramids. Rand said capitalism produced the grand skyline of New York.


Pyramids of Egypt, circa 1900, Public Domain
Rand said the Downward Trickle of capitalism raises the standard of living of all people, and the inhabitants of the slums lead a life of luxury compared to an ancient Egyptian slave. Marx said the slums are where the workers die under capitalism. Marx explained why slums exist under capitalism. Rand did not.


The word "slum" was seldom used after the death of Reagan. Earlier, when the children of the Ten Percent asked "Daddy, what's a slum?", they were told "That's where the poor people live."


The Staffs, promoting enhancements to the Firehose Up, describe how the Downward Trickle, the waste stream of the Aristocracy, conveys a rising standard of living to all people. Several verses of the Professors' song "Growth of GDP" focus on per capita GDP, Adam Smith’s promised equal parts for all by the Invisible Hand. As the 50 Percent pluck their rising standard of living from the Downward Trickle, children starve.


In our next episode of the Fairy Tale of Capitalism, the amazing Invisible Hand will guide the Corporations as they frolic in the Free Market.




My kind friends who read the prepublication drafts and sent me their comments have my sincerest thanks.


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Images


“Ayn Rand” (1925, USSR passport photo, Public Domain, https://commons.wikimedia.org/wiki/File:Ayn_Rand.jpg)


Gottscho-Schleisner, Inc., “New York City skyline” (Mar 14, 1950, Library of Congress, LC-G613- 56750, Public Domain, http://www.loc.gov/pictures/item/gsc1994001246/PP/)


John Jabez Edwin Mayall, “Karl Marx” (circa 1870, UK National Portrait Gallery, http://www.npg.org.uk/collections/search/portrait/mw75680/Karl-Marx, Public Domain in USA, https://commons.wikimedia.org/wiki/File:Karl_Marx_by_Mayall_c1870.jpg)


“U.S.S. Raleigh, sailors at the pyramids” (circa 1900, Library of Congress, LC-D4-20921, Public Domain, http://www.loc.gov/pictures/item/det1994010117/PP/)


Sources

Crane Brinton, “The Anatomy of Revolution” (1965, Prentice Hall, https://www.amazon.com/Anatomy-Revolution-Crane-Brinton/dp/0394700449)

Daniel Brockman, "The Eric Tetralogy: 3: The Firehose Up" (Sep 9, 2017, https://daniel-brockman.blogspot.com/2017/09/FTC-eric-tetra-3-the-firehose-up.html)


Daniel Brockman, “The Fairy Tale of Capitalism: Land and Ricardo” (Apr 27, 2017, https://daniel-brockman.blogspot.com/2017/04/FTC-Land-and-Ricardo.html)

Daniel Brockman, "The Fairy Tale of Capitalism: Workers, GDP and Economists" ( Mar 17, 2017, https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-workers.html)


Alisha Coleman-Jensen, Matthew P. Rabbitt, Christian A. Gregory and Anita Singh, “Household Food Security in the United States in 2016” (2017, U.S. Department of Agriculture,  https://www.ers.usda.gov/webdocs/publications/84973/err-237.pdf?v=42979 )


Friedrich Engels, “The Condition of the working Class in England” (1886 American Edition, first published 1845, republished by Penguin 1987, http://amzn.to/2zzUygE)


Karl Marx (Friedrich Engels, ed.), “Capital” (1867, 2010 republication by Digireads, http://amzn.to/2jmOjac)


Karl Marx and Friedrich Engels, "Manifesto of the Communist Party" (1858, 1908 New York Labor News Edition, http://amzn.to/2hl0LCS)


P. J. O’Rourke, “On the Wealth of Nations” (2007, Grove/Atlantic, http://amzn.to/2zDk9Uc)


Ayn Rand, “Atlas Shrugged” (1957, Penguin, 1168 pages, http://amzn.to/2ytJpuy)


Ayn Rand, “The Virtue of Selfishness” (1961, Penguin, http://amzn.to/2hmkC4u)


David Ricardo, “On the Principles of Political Economy and Taxation” (1817, 2013 Heraklion Press edition, https://smile.amazon.com/Principles-Political-Economy-Taxation-ebook/dp/B00EINTMBI)


Adam Smith, “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776, http://amzn.to/2jjusby)


Adam Smith, “The Theory of Moral Sentiments” (1759, 2010 republication by Digireads, http://amzn.to/2ADCAYL)