3/25/2006 newsletter

*** Market
Market is flat for the week, waiting for FED meeting next week. The market was uneasy at first, but then pretty much expected to see anther quarter point hike on interest rate. Lucent and Alcatel (Franch Telecom) merged to form a 30 bil company with US side (mighty Ms. Russo) controlling the company (friends at LU may be safe for a while). Both companies are struggling, hoping the alliance will regain their past glory. Will this be another "blind leads blind" case? Since this deal is structured as Alcatel acquiring Lucent, this deal can be seen as SP500 dumping Lucent. Google will be added to SP500 on Monday. Finally the IPO found its exit strategy.

My portfolio is volatile this week due to NYX and crude oil price. On the surface, NYX's PE=90 seems very expensive (Google's valuation can not be blamed compared to NYX's). We will see if NYX lives up to that expectation. (The kind of game Mr. Thain plays is quite hard to understand.) BG is sold. I hesitate to sell PCAR. It is a strong company, but the stock does not seem to go anywhere soon.

Big bummer Microsoft, and bad luck me. I was trying to load a few large caps since they look so cheap. So I decided to buy a little bit of Microsoft and Intel as value investors. Who knows the next day Microsoft announced Windows Vista delay and pissed everybody off. The Division VP was fired the day after. What a bummer! The obnoxious Jim Crammer even said, "Who cares about Microsoft any more these days" because its stock has not been going anywhere for 3 years and one product delay after another...

However, technically speaking, the wide flat converging stock price at low level is actually very attractive. And you know all the speculators are out due to one bad news after another and no profit opportunity on both long and short sides. Who is buying it? Intel is a simple technical play, betting $20 is a possible support. It is so cheap. But I am not uninformed, I know Intel is losing to AMD since S&P is broadcasting this bad news to the world. I even read it in a GNU MFP benchmark report before I read S&P report.

I read this JP Morgan CEO story. Very interesting guy...
http://money.cnn.com/magazines/fortune/fortune_archive/2006/04/03/8373068/index.htm?source=yahoo_quote

March time is always the peak of Merck's stock price. Why? Bonus/Stock option. I got some raise and some stock options ($36). But it is priced at the highest level since Vioxx debacle. We will see if Merck can break into $40's. Otherwise, these options are useless... As I mentioned, the stock repurchase is almost certain to lift price, as long as there is no other setback, like Vista.

http://www.berkshirehathaway.com/letters/1985.html

I happened to have a chance to read Buffett's 1985 letter (refered by my Six Sigma book). And I stumbled into another essay on executive pay on stock option. It appears that CEO and Corp HR is not much better than the story of an accountant, the trusted steward, secretly transferring money from his master's account into his own account, little by little. At the same time CEO is portraited an image of heroic visionary, so called "leadership" or even "savorship" -- as long as you do not look at how their compensation are structured. Depending on which side you stand, this "weakness" may not be a bad thing (considering if you are ascending to senior management, of course the more perk the better). Unfortunately things just got really bad these days... Many of them are not far from crooks, very intelligent ones though (like the recent UMDNJ case)... Alas, what a world!

--Steve

3/18/2006 newsletter

*** Market
Of course, it is a good week. SP500, , advancing 2%, moved above 1300 for the first time in 5 years (I thought we could get there last Dec). My portfolio rose to $13.28 (+12% YTD) following Russell 2000's new high. I want the market to correct, but it does not seem to be going down...

Market is full of enthusiasm that we are beyond the dot com bubble and the dreadful financial squeeze of 2002. Some Wall Street firms (LEH, GS) are extremely profitable, in contrast to the struggling semi and software industries. Mergers and corporate restructuring continue in a fast pace. I was reading some article about Graham/Buffett. People went through 1929 crash and would forever remembered the peak (DJIA=380). Even after 20 years, Graham worried DJIA would drop off the toilet again. Who knows we are in that situation again? Graham advised Buffett in 1949 to work in a stable company, wait to come back to Wall Street until the crash is over. Buffett did not listen to him, and 1949 is the onset of the great bull market of next 10 years when DJIA rose from 200 to 1000 in 1960.

(However, I also found that there are some characteristics of Buffett not so easy to "imitate", contrary to the generally perceived. He is a genius on numbers since very young age. He began his "career planning" at age 5. He quited Wharton at age 19, expressing there is nothing to be learned from professors there. He read 2000 annual reports every year. He was surrounded by the top-notch financial minds of 40's and 50's, among which he was the best, and Graham thought Buffett was the brightest disciple of his when he was only 25, which was ridiculed by some participants. Yet Buffett waited 20 years to take over GEICO, the crown jewel of Graham's investment, when GEICO was messed up in 1974 and stock dropped to $3.)

You may hear gurus like Bill Gross and Buffett himself voice a low-return (low means ~6%) period ahead in US (like 70's). They may be right, or may be wrong just like Graham in the 50's. Even in an overall depressing environment like 70's, Berkshire still grew leaps and bounces. People are scrambling to find where the high growth stuff is. Maybe India, China, small-cap, new IPOs, some developing countries, whatever... I have my own method of finding them (with some tolerance of error)...

(Note: A general prosperous impression of an emerging market, such as China, does not necessarily translate to a sure success of investing in public companies there. For example, Shanghai stock exchange has gone through 8 years of bear market while China is growing 10% every year. However, FXI index seems to do quite well.)

I am studying 6-Sigma stuff lately (Merck wants to become a 6-Sigma company). 6-Sigma means you can control a process to produce less than 3.3 defects per million opportunities. I found the topic very interesting because 6-Sigma is very similar to my stochastic approach to stock market (where 1-2 Sigma is the norm). It is mathematical, use statistics (quantitative analysis) to control the variation of product quality and improve financial performance. "Variation is evil" it says. And there is Lean Six Sigma. Lean is a methodology to improve speed and waste. Speed and quality under statistical control (instead of some ego-centric managers) gives a company a winning edge against those low quality peers. Most amazingly, these stuff can also be applied to service organization, where everything goes, bugs are flying every day, fire fighting is a highly-prized heroic activity... Speaking of insanity...

--Steve

3/10/2006 newsletter

*** Market
Speaking of Google, it has been quite volatile lately. The market is correcting this week, especially on the small-cap side, which drags down my portfolio by 2-3%. The large-cap shakes but did not drop too much. There are a lot of talks about the interest rate. And the fact that Berkshire is buying foreign stocks is making people uneasy about the fate of US stock market in light of large trade deficit (Buffett is patriotic about his country. But he is even more loyal to his shareholders. He will do what is best for his company, even that means to short on the country's currency).

NYSE (NYX) and AX merger has completed. The stock has been there for a year and all of sudden the name is changed and people want to buy it... It is crazy that NYX rose 24% on the first day of trading with 20 million shares (that is 1/3 of the company). It is a merger, not an IPO. But people treated it as a hot IPO. It rose to become my top holding now (~5%). Although I made some money, I am not happy about the irrationality. The high valuation of NYX also make other exchanges more expensive. London Stock Exchange turned down a bid from Nasdaq
today, citing not giving it enough valuation. This could become the next exchange bubble if you are interested in bubbles.

I hope you enjoy Mr Buffett's latest commentary. I like the paragraph on CEO pay and the Gotrock family. I share a similar view on CEO pay although you need to face the fact that it is not going to change soon, especially in those lousy companies, which high pay only accelerates the fall. CEO is very similar to the money manager on Wall Street, their first priority is to make money out of the company and shareholders, the second priority (if any) is to bring value to the
table. That is why I insist a fatpitch approach, which I prefer to invest in companies where large major investors is present. This will somewhat eliminate the conflict of interest between management and shareholders. (Remember the pure math -- each dollar given out in salary is substracted from the earning on the balance sheet.)

The Gotrock story is particularly alarming. I have studies hedge funds lately and I have been puzzled how can hedge funds (as benchmark shows) bring any value to investors if they charge 20% fee. Buffett expounded it very well. There is no way that hedge funds as a whole can outperform common stocks as a whole by a large margin like 20% (remember mutual fund managers charge about 1-2%). In order to gain such large advantage, hedge funds have to be highly leveraged, which lead to a very short life span of 3 years. That is, they will
outperform for a few years and take your 20% incentive pay. All of sudden, the fund will collapse during a trend reversal and they just close the fund and walk away. Sorry, you have lost ~100%. This is the fameous saying, "No matter how much your asset is, it multiplied by zero is still zero." Typical fund managers are not interested in going through the hard time with you because they do not make any money if the return is negative. They whould just dump the
fund and go establish a new fund. What are you going to do here?

And I also notice the largest sector of hedge funds is still in the stock market (long/short equity). Therefore, it is not very convincing to me, by having the ability to short and use option, the hedge funds can do much better than mutual funds. If it is so easy to do, why not common stock companies do that? Then that advantage will be reflected on the long side as well. About
leverage, companies use leverage already (bonds). The fact that fund managers use leverage is saying CEO does not take enough risk. Why not the borrowing implemented at the company level, instead of fund level? (It is less expensive). Long/short eliminates the market risk, and the performance is solely dependent on the fund managers choice. But it also eliminates the growth
of the market, which by far has been recognized as the only long-term driver of capital growth. Sometimes, I do not understand why one wants to eliminate the market (risk). Bear market... yes. But not bull market. And SP500 is a long-term bull.

My axiom is, Let those managers who know how to make money do their job. Don't try to become the manager of those CEOs. Become their partner. (Buffett uses "partner" if you ever notice.) All you need to do is to find out who are the good guys and stick with them. Leave the bad guys alone. I am not interested in shorting them, nor timing them (option).

--Steve

3/3/2006 newsletter (Feb Performance)

*** Portfolio
Feb ended flat. My portfolio is up less than 1%, lagging slightly behind SP500, Russel Midcap, and Smallcap. Selloff on energy stocks contributed most downside. Exchange stocks contributed to the upside. Is energy story finished like the housing industry 6 months ago. There are evidences of that, but the performance has not been widely deteriorating. It is hard to call it. On the other side, exchange sector and investment banking sector are prospering quite well. Trading/Hedging, Merger/Spinoff will become the norm of corporate life.

*** Market
I thought Feb will be correcting. But SP500 still has quite a momentum. It is very hard to predict the market. This is why I am not doing it. I am practicing a skill called "piggy-backing". I will explain it later if you do not know what it means. Google exhibited large volatility which makes major indexes unstable. I think a major investor has bailed out this week. Google is making people uncomfortable. It is saying it will run the company as a 100 billion company. What? Google is "already" a 100 billion company. If it is running "like" a 100 billion company for the next few years. Its stock will make no gain at all. Am I missing something here?

*** Comment
http://en.wikipedia.org/wiki/Piggyback
Now piggy-back? From our upbringing, we were taught smart students do not piggy-back. You study on your own and read and think independently. We think piggy-back is only for those uneducated people. Now I am telling you a good approach of investment is to piggy-back? Is this a loser's game or what?

It turns out the difference is that, business process is an active process, while investment process is a passive one. You need a different metality to approach them.

Piggy-back means you mimic something. If that something prospers, you prosper. If it suffers, you suffer. Speculation is a form of piggy-back, you piggy-back on a hot trend, hoping the rising tide will carry you higher. You do not have to spend much effort to carry your own weight. But I am not telling you to speculate. I am telling you is to piggy-back on a major index. That is you make sure your investment correlates well with a major index. You do not want to be out of step with the major index too much. Hopefully, when you are out of step, you are moving better than the index.

Piggy-backing does not requires whole lot of "skills", but requires a lot of "faith". You may need some "skills" to pick stocks (if you think those skills worth something), but how much skill does it need to buy SP500 index? This is why Benjamin Graham talked about the temperament of investors is more important than his "investment skills". Even you applied your "skills" and bought a stock and prepare to hold it for 2-5 years. What can you do after you bought it? There is a similarity to religion. In the Bible, we are told to rely on God. Not by our own strength. But His mighty power. Not relying on our own righteousness. But trust what has been accomplished by Jesus. When you ponder to trust God / Jesus, you must have asked, How do I know God will do well ? (Since I am not relying on myself) How do I know God's strength is sufficient? Is Jesus effort enough to save me? Don't I need to do something to compliment God? You will ask the same questions in the investment process.

When you buy a stock, you entrust your money to the management team of the company. Since you do not know those few people can be trusted, it is better off to buy an index or mimic an index (by diversification to a group of stocks). When you buy an index, you trust the group of the companies "as a whole" will do well. When you buy SP500, you trust Corporate America will do well. When you buy MSCI World index, you trust the free economy of the world will do well. Will they? Nobody knows. But if history is a proof, they did, and they probably will continue to do so. On the other hand, if the whole world suffers, well, it is okay you lose a few bucks. You are not worse than other people. And there are enough choices out there to keep you busy selecting even in the index world if you still want to be an active investor.

This type of piggy-back turns out to be one of the most successful investment strategy a layman can have. If your experience can prove otherwise, God bless you. If not, you need to think about it more seriously...

Steve