Wednesday, September 24, 2008

Book Review: The Eccentric Billionaire

In the early 1970s, John D MacArthur was one of only five American billionaires. Far less has been written about MacArthur than his four contemporaries (Howard Hughes, J Paul Getty, D K Ludwig and H L Hunt). To a large extent this is because MacArthur's story is far less colourful than the other leading tycoons of his day. This does not make MacArthur either uninteresting or uneducational. While Nancy Kriplen's biography provides a very readable summary of MacArthur, it feels somewhat light on detail and the anecdotes that often illustrate the character of the subject.

After a relatively lower class (but not impoverished) childhood, followed one of his elder brothers into the insurance business working as an insurance salesman before eventually buying his own insurance company and growing Banker's Life and Casualty into one of the larger insurance companies in America. Profits from his insurance business were reinvested in real estate. The rise of MacArthur's business empire and his eventual decision to leave the bulk of his fortune to charity (allegedly to reduce the amount of his estate that would be lost in taxes) are covered in sufficient detail.

At a personal level, the biography conveys some measure of what MacArthur was like as a man: driven, frugal in the extreme, dysfunctional as a family man, generous to people he liked, litigious and so on.

However, at the end of this relatively short book (the main text is only 175 pages long) I was left with the impression that I had been presented with a summary of the man and not a detailed study of his life. In short, while I learned a little bit about MacArthur, I was disappointed at the lack of depth.

Monday, September 15, 2008

Restoring emotional capital

In terms of my personal finances, 2008 is rapidly developing into the worst since the Asian crisis. Commodities and equities have all shown negative returns. Currency movements have been negative. The income from my job has declined about 11% since April and is expected to decline further. My overseas properties have fallen somewhere between 10-15% (est) over the last 12 months.

The only positive news is that mortgagee values of Hong Kong properties (which are far and away our biggest asset class) still stand at higher levels than at the beginning of the year. Given that transaction volumes have fallen sharply and people are beginning to accept both (i) that the global financial crisis and (ii) the slowing of the PRC economy are going to have some impact in Hong Kong, it is hard to see property prices staying at current levels.

My decision making has been mixed. Accumulating cash has been a good call (in spite of the corrosive effect of inflation) as was cancelling my monthly contributions to two small cap funds. Unfortunately, I made far too many investments in falling markets, all of which have shown losses this year.

In short, my emotional capital is currently at very low levels and my confidence both in financial markets and my ability to make the correct decisions is also low.

How to restore that emotional capital? There are several obvious steps:

1. stop making decisions for a time. I have been through three severe economic contractions during my adult life. In all three cases, superb opportunities have been presented .... for those who are both patient enough not to invest too soon and brave enough to invest before it is recognised that the crisis is over. I should impose a moratorium on new investments for a few months. I should, but I suspect that will be a hard resolution to keep;

2. review current investments. Previous experience has shown that quality assets will recover their value. It is the more marginal assets that are at risk of loosing all their value. I have already taken losses on silver and exited the Lyxor commodities ETF at a modest profit. No decisions have been taken regarding my remaining investments;

3. consider job security. My income has fallen and is expected to fall further. There is not much I can do about it. Job security is reasonable and the combination of a long notice period and a tail on my income, gives me a degree of security that is good by private sector standards .... but not assured;

4. focus on the positive. Recessions require less time in the office and allow more time for other things. I'm still waiting for the work loads to fall off a bit, but actually looking forward to having less to do in the office (and a fall in income is an acceptable price to pay for a better work life balance);

5. pay off some debts. I have no difficulty in carrying my mortgages even during a recession. However, if I am not making new investments of any substance for some time, repaying a mortgage or two is an acceptable alternative to holding cash;

6.catch up on the backlog. I have a very long list of things that need to get done (both at work and outside it) or which I want to do. Now is a good time to make a start on those projects (and hopefully finish a few). The sense of accomplishment will be good antidote for the general feeling of negativity.

Anything else?

Wednesday, September 10, 2008

Is this capitulation?

Up until the middle of last week, the daily read of newspapers, blogs and other financial commentators produced a wide variety of views on the current state of financial markets. Typical sentiment included the mildly optimistic ("this is a good opportunity" and "we are seeing value based opportunities"), the hugely pessimistic ("housing is still over valued", "deleveraging has only just begun" etc) and the indecisive ("it could go down further before it goes back up"). Recommended actions varied accordingly.

Towards the end of last week there was a noticeable shift in tone towards the hugely pessimistic. There is far more talk about how much further markets have to fall, how bad the recession is going to be and investors starting to cut their losses (especially in commodities). Talk of value and opportunity became increasingly hard to find.

The question I have to ask myself is whether we are getting close to what Sir John Templeton would describe as the point of "maximum pessimism"? Obviously my ability to predict the future is no better than anyone else's (and my track record this year has been generally bad). However, instinct and experience suggest that hopes of a short downturn, a mild recession and a quick recovery appear to be fading. We are also beginning to see meaningful evidence (beyond the anecdotal) that the current economic problems which originated in the United States are spreading to Asia.

As hard as it is to admit to being wrong, I have decided to cut my losses on some of my investments and hold more cash. I have placed orders to sell the last of my remaining holding in the Lyxor commodity ETF (at a small profit) and silver (at a material loss). I am reviewing my other investments but will probably ride out the equity funds and be content to build my cash until I have a much higher degree of confidence that the scope for further downside is limited. One of the points I will have to keep reminding myself of is that markets tend to lead the economy - stock markets have historically rebounded before the underlying economy rebounds. In effect, the best time to buy aggressively is while most "experts" are still negative.

I have also recently revised my income expectations down by 10%. That is starting to look insufficient. I will rework the numbers over the weekend, but will probably need to reduce my income expectations further.

Monday, September 08, 2008

Book Review: The Black Swan

Nassim Nicholas Taleb's "The Black Swan" (subtitled "The impact of the highly improbable") is a provocative and interesting read. The real strength of "The Black Swan" is that it prompts the reader to think and, in a few places, challenges some of my beliefs (or at least made me consider them anew). That alone makes me rate the book highly.

Among the book's many high points are the way it produces good reasons why financial analysts, economic forecasters and governments (among others) are not worth taking too seriously (Taleb describes them as being more or less fraudulent). This alone justifies the book as a seriously good read from an investing and financial planning stand point. That said, this is nothing new (see "The Zurich Axioms" by Max Gunther as another example). The track record of people who forecast the future is pretty dismal. Even Nostradamus has a pretty mediocre track record compared to his reputation. His criticisms of classical economic theory are also well expressed (although there was nothing novel in Taleb's views).

I did not agree with all of Taleb's views. As examples (all paraphrased):

1. The problem of the upper bound: I disagree with the notion that there is no practical difference between knowing that there is no upper bound and knowing that there is an upper bound but not knowing where it is. Often there will be no practical difference but in some situations, knowing that there is a limit to the matter under consideration (however uncertain) will have implications for decision making. The turkey problem can illustrate this point. The turkey has no idea of how big he will get, but knows that at some point its growth will come to an end (reach its uncertain upper bound) when it becomes someone's dinner. For the turkey the difference is significant;

2. The reasoning that it is necessary to conceive what technology will be invented in the future in order to predict the future is impossible to obtain because if we could know what technology would be available in the future we would invent it now, thereby rendering the prediction meaningless does not hold up to facts. The concept of a flying machine was conceived centuries before a practical flying machine was built. The concept of space flight was around for decades (at least) before Sputnik.

There were other items as well.

I have mixed views on the barbell strategy. Sure, it would have been an ideal investment strategy over the last year or so with declining stock markets. However, I have to wonder how it would have performed (in both absolute and relative terms) if we had unexpectedly high and persistent inflation.

Taleb's writing can be irritating. He comes across as being overly self opinionated and a man who has a very high opinion of himself (and a low opinion of many other people). It would have been a more pleasant read if the author had been a little bit more humble in expressing his views.

In conclusion, a very thought provoking and interesting read. Highly recommended.