Cheaper but not cheap

According to the April 20th issue of Barron’s, the price/book ratio of the S&P Industrials is around 2.17.  This figure was well over 3 a year ago and as high as 10 back in 2000.  That said, the historical average (excluding the mega-mania of the 1990s-200s) is around 1.7 times book value.  The bear market has brought overall stock market valuations to their lowest level since the late 1980s.

I’m no longer ultra-bearish on the overall stock market, but the bear market may still be far from over.  I have NO IDEA how low valuations will drop, when the bottom will be, or how low the bottom will be.  I do recommend keeping some exposure to stocks, as the lowest valuations since the late 1980s should mean that there are now some bargains out there.

I have been intending to buy more stocks, but the two things that have been stopping me are being busy with other things in my life and my fussiness in selecting stocks.  I don’t buy based on the popular stats like PE ratios, price/book ratios, or price/sales ratios.  Before I buy a stock, I crunch through the numbers from the official financial statements, and I also think about what risks there might be that the past financial performance of the company don’t reflect.

One example that I considered but passed up is VDSI, VASCO Data Security International.  This business security systems/products company generates an enormous amount of free cash flow on very little plant/property/equipment, has more than enough cash on hand to pay off ALL liabilities, and has a management team more concerned about running the business than brown-nosing Wall Street.  The price has dropped precipitously in the face of fast AND profitable growth.   I learned from the book _The Little Book That Builds Wealth_ (a book that explains how to find companies with economic moats) that business services companies prosper due to customer switching costs.  (Switching to a competitor would be such a logistical nightmare that customers rarely do it, and that gives the company plenty of pricing power and high returns on its capital.)  However, I am concerned about the possibility
that VDSI’s technology could become obsolete as well as the possibility that one security breach could damage its reputation and allow a competitor to emerge from nowhere and take over its market share.

Another factor that I weigh heavily is something I call net liquidity – liquid assets minus ALL liabilities.  If a company has a non-negative net liquidity, that means that it could pay off all liabilities immediately without having to resort to a fire sale of assets.  A non-negative net liquidity is quite an asset given the tight credit markets, but most companies out there have negative net liquidity.  I don’t eliminate companies with a negative net liquidity, but it is a factor in my appraisal process.  Too many companies out there have an enormous negative net liquidity that dwarfs their annual free cash flow.  You can see why so many companies have been cutting back on investment.  On the other hand, a company with substantial positive net liquidity has room to grow without having to rely on borrowed money.

Model Portfolio: 2008 in Review

From inception on May 8th, 2008 to December 31st, 2008, the Doppler Value Model Portfolio went from a balance of $100,000.00 to $98,926.18 for a loss of 1.1%.  Although the Doppler Value Model Portfolio lost money, it overwhelmingly outperformed every major market index, such as the DJIA and S&P 500.  The Japanese yen investment (FXY, CurrencyShares Japanese Yen Trust)  did very well, and the Everbank Hong Kong Dollar CD outperformed cash (which isn’t saying much given pitifully low interest rates), but Berkshire Hathaway Class B (BRKB) and the Japanese stock investment (DFJ, WisdomTree Japan Small-Cap Dividend ETF) both took hits.

It’s only because I was having difficulty finding bargains and then too busy to look that I kept more than 60% of the portfolio in cash.  The Doppler Value Model Portfolio didn’t miss my attention.  If I had gotten around to deploying more of the cash, the portfolio would have taken a much bigger hit than a 1.1% loss.

Despite the possibility of further losses, I am determined to deploy most or all of the cash balance.  Since the stock market has much lower valuations now than was the case when I first started this blog, I should be able to find bargains in the weeks and months ahead.  Treasury Bill yields are microscopic.  The combination of Helicopter Ben, trillions of dollars in bailouts added to the already enormous national debt, and the monetization of this debt (Fed printing money in order to buy the debt securities)
threatens to jump-start hyperinflation.  In this Brave New World, US Treasury Bills are now a potential time bomb instead of a safe haven.  While we all still need cash for everyday expenses, the proverbial “rainy day” (especially in this economy), and expenses coming up in the next few years, we cannot expect our cash to hold its value.  When inflation does strike, Helicopter Ben will be slow to raise interest rates, which will quickly erode the value of cash and fuel even more inflation.

OT: update on my life

I apologize for not keeping the Doppler Value Investing blog up-to-date.  I have been busy with a number of matters in the past several months.

Last fall, I started a new job and moved to central Minnesota about 60 miles west of Minneapolis.  Hopefully, no more disasters will follow me here, such as the Cedar Rapids flood of last year, the Beltway Sniper spree of October 2002 (when I lived in northern Virginia), or the September 11th attacks (also when I lived in northern Virginia).  The current flooding along the Red River along the Minnesota/North Dakota border is a reminder of what I witnessed in Cedar Rapids, Iowa last year.  I feel like the character Sidney Prescott from the Scream trilogy.  At least I wasn’t directly affected by these disasters, but it is freaky.  Also, I’m not the same gender or as good-looking as Sidney Prescott (or Neve Campbell).

Since moving to Minnesota, I now understand the meaning of the word “cold”.  This has been the coldest winter I ever experienced in my life.  I grew up in the Chicago area, and even the legendary bitterly cold winters of the late 1970s and early 1980s weren’t this cold.  Here in central Minnesota, subzero morning temperatures in winter are common.  We even had multiple mornings with temperatures colder than -20 degrees and a mid-March morning with a temperature colder than -10 degrees.   A large number of people around here own snowmobiles, compared to just a small percentage in the Chicago area and Cedar Rapids.  Many people go ice-fishing around here, whereas nobody does that in the Chicago area or Cedar Rapids.  I learned that people use fish houses for ice fishing.  All those silly cartoons I watched as a child led me to picture ice fishing as cutting a hole in the ice and then spending the day sitting in a chair and shivering while waiting for a bite.  In reality, people sit in the comfort of an insulated and heated fish house while waiting for the fish to bite.

I have been meaning to buy stocks for both my real portfolio and model portfolio.  However, I haven’t gotten around to this.  Given the performance of the stock market since I started this blog back in May 2008, you and I should be thankful for my procrastination.

I intend to buy undervalued stocks in the weeks and months ahead.  I have NO IDEA how much lower the stock markets will drop or the timing of the market bottom.  However, bargains are much more common now than was the case when I first started this blog.  I will share some of my research here on this blog.  I will NOT wait for the market bottom to buy stocks, because I have NO IDEA when that will be.  Cash continues to be an unattractive asset class due to submicroscopic yields on Treasury Bills and the growing risk of higher inflation in the future.

I believe the risk of hyperinflation has increased since I first started this blog.  Trillions of dollars have been appropriated for bailouts, and the Fed has become more and more willing to buy various debt instruments, including Treasury Bonds.  When the central bank buys debt instruments from its own government, this is called monetizing the debt.  The US government doesn’t actually have trillions of dollars in cash lying around, so it has to borrow money buy selling Treasury Bills, Notes, and Bonds.  The Fed has announced that it is more than willing to buy these Treasuries.  So the Fed ends up printing money to bail out the greedy and careless bankers.  Printing those extra US dollars dilutes the value of each individual unit.  Buying those Treasuries means that prices are pushed up, and the yields to maturity are pushed down.  The resulting low interest rates fail to keep up with the latent inflation, which only increases the inflationary pressures further.

Although deflation seems to dominate at the moment, I believe that it will eventually give way to high inflation.  I have NO IDEA when the transition will happen.  However, I am certain that many people will become poorer in the deflation, the inflation, or both.  I am also certain that virtually nobody will time the transition accurately.  Trying to conserve capital during both the current deflation and the later inflation will be tricky.  Treasury Bonds do well in deflation but are a death trap in hyperinflation.  Commodities and metals will do well in the hyperinflation but may fare very poorly in deflation.  There really is no such thing as a safe investment anymore.

:) Ben Bernanke should date Jessica Simpson

Some of of you think I’ve been too harsh on Federal Reserve Chairman Ben Bernanke. I apologize. To show Bernanke how nice I am, I’m writing this post to show him a way to keep his reputation intact no matter what happens to the economy and financial markets.

Until recently, Tony Romo of the Dallas Cowboys has been dating singer Jessica Simpson. The media blamed her for Romo’s mistakes on the field and the Dallas Cowboys losses. Of course, they didn’t credit her when things were going fine for Romo and the Cowboys.

But all this gives me an idea. Helicopter Ben should date Jessica Simpson. She should show up to watch him at FOMC meetings and Congressional hearings. You know that Helicopter Ben would NEVER be too cheap for her, because all he has to do is print extra money to accomodate all her trips to Rodeo Drive. If anything happens to the economy, everyone has an easy scapegoat – her. After all, Jessica is the dumb one who had to ask if Chicken of the Sea is chicken or fish, thought buffalo wings were made out of buffalo meat, and spent $1400 on a set of Egyptian bedsheets that she ended up not even sleeping on. So the media can then blame everything that goes wrong with the economy and financial markets on her, and Helicopter Ben and Easy Al.com can get off scot-free.

NOTE: I hope I made it clear that this is not a serious post.

US Treasury Bills: no longer a safe haven

I used to regard US Treasury Bills and the Vanguard money market funds that hold them as safe investments and a good parking place for money awaiting a cheaper stock market. However, we are now in a new era of consistently negative real interest rates.

Inflation in and of itself isn’t the problem. It’s inflation accompanied by low interest rates that is the problem, and that will fuel even more inflation. Higher inflation accompanied by falling interest rates means an even more negative real yield, and the spiral has the potential to feed on itself.

Bernanke’s decision last September to make a bigger-than-expected cut in short-term interest rates just weeks after he publicly worried about inflation was the incident that finally proved to me that we really are in a new era and that they don’t call him “Helicopter Ben” for nothing. Subsequent events have only reinforced the case for more inflation.

In the 1950s-1990s, you could count on the Fed to maintain positive short-term interest rates. Any time inflation went up, interest rates would follow suit. Thus, Treasury Bills were a hedge against inflation. But the Fed of the 21st century has turned the financial landscape into a bizarre Alice In Wonderland world where Treasury Bills lose purchasing power. We have already seen Easy Al.com drop interest rates to near 0 in 2002-2004. As the credit/economic crisis continues to unfold, Helicopter Ben will keep dropping interest rates, which I think will approach 0% like they did during Easy Al.com’s big loosening. Inflation has been picking up over the last several years, but so much hanky-panky has been thrown into the CPI and PPI calculations that you can’t make an apples-to-apples comparison with 20th century inflation rates.

It is sad that there is now reason to lack confidence in the US dollar. It used to be that only survivalist kooks worried about hyperinflation. But Easy Al.com got the inflationary ball rolling, and Helicopter Ben is working hard to debase the US dollar into oblivion. We are now in a new era. In this Alice in Wonderland world, everything is a risky place for your money.

NOTE: Although cash equivalents are now guaranteed losers as investments, this does NOT mean cash is trash. If you live here in the USA, you still need US dollars to pay your expenses. So you still need to keep your rent money and the customary “emergency fund” in US dollars. It’s your longer term investments that face the big inflationary risks.