Steven F. Schreiber, CFA - The Bottom Line

The Paper Growth of the US

There are two ways an economy can grow: it can increase the amount of work by its labor force or by increasing the productivity of its labor force. Only by increasing one of these two things can an economy truly grow. In the past 8 years, the US economy has grown significantly according to the GDP numbers that are published by Bureau of Economic Analysis. Has the US labor force grown? Not really. Has productivity improved? Not really. So how has the economy grown so significantly? I call it the paper growth of the 21st Century.

All economic data have been pointing to a slowdown in the past decade, especially in the past year. The response by the Federal Reserve and the US government has been to do whatever necessary to ensure that the GDP continues to increase. The result has been short-sighted pumping of liquidity into the market to produce apparent growth without substance. With interest rates so low, companies borrow money for the sole purpose of buying back stock to increase short-term stock prices and reward its executives. There is no productivity gained with much of the borrowing. This defeats the purpose of low interest rates and only serves to create a larger bubble. And the more significant consequence is that companies are burdened with more debt in an economy that is shrinking, with no productivity gained to cover the interest payments.

But at least the executives will get their bonuses because of the increases in stock prices.

This type of growth serves the sole purpose of increasing the income gap between the wealthy and the rest of the country, digging a deeper hole for the economy. Nearly the entire country is worse off than it was 8 years ago. Income has not grown for many people, prices have increased significantly, and personal wealth in the form of real estate has dropped significantly (a large share of many Americans' wealth is in their home).

Inefficient Labor Market

Excluding the top earners in the US economy, Americans on average have seen nearly a decade of stagnant wages. Most of us are worse off than we were 8 to 10 years ago due to, in many cases, lower wages coupled with higher prices (for homes, food, gas, cable, etc.). The structure of our labor markets and capital markets are the cause of this problem. In short, our market for labor is inefficient, meaning it takes a long time for prices (wages) to adjust to supply and demand.

Lower to middle workers have little to no bargaining power when it comes to wages. Only the highest earners have bargaining power. If a mid-level worker counters a job offer, it is extremely rare for the company to accept the counteroffer. In nearly all cases, the company will simply say no to increasing their offer, leaving you to either take or leave the offer on the table.

There is poor information on salaries, making it more difficult to now the market rates. In addition, there is little uniformity in job descriptions and responsibilities, and salary information is one of the most confidential information a company holds. Without accurate information, workers have less bargaining power. The opposite is true for executive level positions. Information is available to the public, so candidates for the highest level jobs have information to use in the negotiations.

The extreme emphasis on quarterly earnings pressures companies to continuously cut costs or hold them flat...in many cases this translates to layoffs or insignificant pay increases for mid to lower level positions.

In years that companies perform well, upper level workers receive performance-based compensation and bonuses. When the company performs poorly, salaries are rarely cut for the upper level. For lower to mid-level jobs in good years, salaries are the same or slightly higher. In down years, jobs are eliminated, and in many cases, hired back later at lower rates. Many companies do not have performance compensation plans for lower or mid-level workers.

Our society discourages an open market for low and mid-level employees. Workers seen looking for new jobs are regarded as obstinate and lost causes. Job searching needs to be conducted secretly, and often it is not feasible to leave work during office hours to travel to an interview. Conversely, when a high level executive position becomes available, it is almost expected that qualified candidates bid for the position.

Boards of Directors or compensation committees are assigned to make sure upper level candidates accept the job offer, leading to exorbitant salaries. Lower and mid level positions are determined by either finding the lowest-priced qualified candidate, or by finding the lowest price that any of the qualified candidates will accept.

When a company hires a position, it interviews multiple candidates within a short period of time to determine the best candidate at the best price. It is normal for an offer to be made when several qualified candidates are found, so if one does not accept a low offer, there are still other qualified candidates. When a job seeker looks for a job, often it is over a period of months or even years, so there is little opportunity to compare offers from several positions or several companies.

Workers are highly discouraged from leaving a company with fewer than a few years of service. Most companies see this as a strong negative for a job candidate, limiting the potential for workers to find the highest paying position.

Undoubtedly there are many more factors than those listed above that cause inefficiency in the US job market. These are barriers that if not eliminated or surpassed will lead to increasing income inequality and years of stagnant wages for lower and middle class workers.

Treat your life like a business

Successful businesses grow, resist difficult times, and pay lucrative compensation to its owners, shareholders, and employees. For successful personal financial management, I recommend treating your life like it is a business. Think of yourself as the owner of your business, your family are the shareholders (and possibly employees), and your goal is to maximize the returns to all of the stakeholders. Most people will find that if they follow these guidelines, they will avoid many of the financial problems that a great number of people face.

Create and manage a budget and follow it strictly. Do not spend more than you have, and make sure your plan allows for a net profit to be invested in the future. If your budget shows a net loss, you should either cut costs or increase revenues.

Invest if the future of your family. Use your profits to spend on items that will benefit your family in the future...education, training, investments, assets, etc.

Maximize your revenue. Always look for additional revenue streams to add to your business (life), such as selling on e-bay, advertising on a blog, a part-time job, investments, etc.

Successful businesses improve gross margins with purchase discounts and rebates. Don't pass off discounts and rebates that may take some time, but will increase profits.

Don't be afraid of leverage, as long as you can pay the interest, and ensure that the borrowing is for an asset that will either increase in value or provide income greater than the interest (such as a house or business).

Always look for ways to cut costs and pay the lowest prices. Your purchasing department should compare prices from various vendors and choose the best bargain on all purchases.

Do not add to your payroll if you cannot afford it. Make sure you carefully consider all of the costs and benefits to adding to your family.

Make sure your employees are happy...make sure you spend on vacations and other ways to improve the well-being of your family.

Hedge your costs. Well-managed businesses hedge the major costs of materials that they need to operate. For a family, they typically include fuel (oil), food, home costs, energy, telephone, etc. Hedging is usually best to do when costs are low and you can "lock-in" low prices (ie, now might not be the best time to hedge fuel costs, since oil prices are at record highs). A way to hedge costs could include investments in ETF's that track commodity prices, energy companies, etc.

This Recession Might Be Magnified

If you listen to the financial reports these days, the consensus seems to be that we will enter a short and mild recession. However, there are various factors present in today's economy that may not allow us to pass this recession so easily as in the past. We are seeing just about every day reports of major corporations cutting jobs. It is no secret that unemployment is up and job losses are continuing. What makes this recession more dangerous is that the people losing their jobs have no equity in their houses they can use to pay bills...nor do they have cash saved in emergency funds. Why do I expect this recession to be longer and more severe than past recessions?

There is little home equity to help the middle class workers who lose their jobs

I don't see any new innovations or demographic changes to help drive productivity and consumption...in fact, we see the opposite. Demographic changes are pointing to less productivity.

Our credit is tapped out...we have no borrowing poser left in our houses or credit cards. Consumers can't borrow any more. Plus, interest rates are already low...we can't go much lower if the economy continues to worsen.

The weak dollar make it more difficult for the US to borrow. The credit of the US is weaker with the weak dollar.

The entire country is already carrying too much leverage. Leverage is great when times are good, but it makes bad times even more difficult.

The only human resource this country can look to for productivity is foreign workers...provided our federal government can figure out how accept enough foreign workers to meet demand. And the problem here is that the well-educated baby-boomers are retiring and being backfilled by lower-skilled foreign workers.

Prices are continuing to increase. We haven't seen much CPI data to support this yet, but food and energy price increases will force other price increases. There is a lag between the time energy prices increase and the time manufacturers of other products will increase prices to cover these costs.

Our country's wealth is held by too few people. We are depending on the wealthiest 10% of the population to increase spending and consumption to carry us out of this recession. However, when spending increases, these same people are just becoming more wealthy, adding even more strain to the middle and lower classes.

US companies are no longer the dominant companies. We are losing out to foreign competitors. The best-run companies come out of downturns as stronger companies. These will be foreign competitors.

IS US Capitalism Dying?

When the free markets cease to determine prices, quantities, and profits, the system of Capitalism fails to function properly. Government intervention is one way to interrupt the free markets. The Government's role in Capitalism should be to ensure that free markets determine price and quantity. Unfortunately, we are seeing more and more cases of the US Government intervening in ways contradictory to the Capitalist system.

Bail-outs disrupt Capitalism. Especially bailouts of companies involved in Oligopolies or "cartel" like environments. The US financial system is dominated by few players with access to a disproportionate share of the world's wealth. Government regulations created this type of environment by creating barriers to entry. Now, we are in a catch-22 situation where these institutions that control so much money are not exposed to free markets. A free market would let the inefficient companies fail and give rise to competitors. We bail out Bear Stearns to drive its competitors out of the markets. These competitors could have a product or business that is much more efficient than Bear, but we no will never know.

Government should not control the market price of money. I disagree with any Federal manipulation of interest rates. The Federal Reserve creates and destroys bubbles with its interest rate manipulation. The availability of credit should be determined by the market...the market knows best when the market needs credit or when it should limit its access to credit. The Fed's solution to any financial slowdown is to increase the debt load of the markets...which seems contradictory to common sense. Slowdowns are the times when the weak players should be exposed and the strong or new competitors emerge. Making money almost free (artificially) by dropping interest rates only prolongs the failure of weak players in the markets and encourages irresponsible borrowing.

How To Ruin the World's Strongest Economy

It seems like our government and Federal Reserve are doing as much as possible to send our economy downward. Week after week we are seeing acts of desperation that are attempts to jump-start an economy and prevent a recession that are only making matters worse. Here's a list of some of the quickest ways to ruin our economy:

Bail out any major corporation that is near bankruptcy due to poor management, over leverage or excessive risk. Don't let the free markets weed out the weak players, rather let them continue to pay multi-million dollar salaries to executives by using taxpayer dollars for the bailouts.

Drop the interest rates down so low that corporations are encouraged to over-leverage their business, so when the downturn finally arrives, we can bail them out with tax dollars. Don't forget that leverage is good when the market is good, but it is very dangerous when the market is bad.

Swing interest rates up and down sharply to try to get the stock market to return 10% annually, making sure the stock market dictates monetary policy.

Allow corruption in public corporations by allowing salaries of top executives to be set by directors, ignoring any conflict of interest.

Hold minimum wage down low enough to just barely pay for rent and utilities.

Allow usury and call it the credit card industry

Make sure this country's workforce cannot grow by restricting immigration

Spend billions in a stimulus package that hands out small amounts to many people to spend, but has no provisions for true economic growth.

Create tax policy that allows the wealthiest taxpayers to pay a lower percentage than most middle class taxpayers.

The Folly of Index Funds

The common thought of investing is to put your money in an index fund and let the compounding make you rich. Talk to any investment advisor and they will tell you that the stock market over the long run will return 10%, so invest $X today, add Y% of your paycheck and in 40 years when you retire you will be a multimillionaire. The problem is that this data is taken from less than a century of data from a country that experienced growth in population and technology that has never been seen in the history of mankind.

The 20th century in the US was one that saw a number of advancements and demographic changes that boosted the economy in ways that will be difficult to repeat. We saw a baby boom, women entering the workforce (almost doubling the workforce), huge immigration waves, the invention of the computer, explosion of the auto industry, aviation, medical breakthroughs, financial innovations, etc. This created an expectation of the ability to continue and repeat these same advancements. This created the expectation of an ability to sustain a growth rate of 6% in the GDP and 10% in the stock market.

Unfortunately, everything has a limit in the amount it can grow. Every market passes through multiple phases of growth, including startup, hyper-growth, maturity, and decline. Nearly every company goes through these phases, and countries and civilizations do as well. The only difference is that the time frame is much different for companies than it is for civilizations. I see the US entering its maturity phase, where the days of high growth are ending. I don't see any drivers that will allow the country to continue its expansion phase like it has in the past few decades. This country has squeezed as much productivity as possible out of its population with both men and women working. The only remaining resource for manpower is immigrants who typically are not as highly skilled as American workers, and who as of now have not been very welcome in this country. Our well-educated baby boomers are leaving the workforce, while lower-skilled immigrants are entering the workforce. This is not a good demographic change for this country.

The only other way to increase productivity is by technological advancements that allow the people to work more productively. I am still waiting for the next breakthrough that will allow that to happen.

Still, the country is lacking in untapped resources to grow productivity...we are reaching the saturation point of productivity. At this point, we must rely on immigration and technological advancements to increase productivity, both of which at this point seem to be at a standstill.

What does this all mean for your money? I no longer agree with the idea that you should put your money in an index fund, let it sit, and hope it grows 10% per year. I see very little that will allow this growth to continue. At a time when index funds are most popular, the investor that makes money will go against this trend and be a stock picker and a trader. Put your money in new technologies and smaller companies that will emerge in the future as the leaders of the economy. Put your money in other countries that have yet to experience significant growth, but are on the verge. Take your profits while you can if you own mature companies and take advantage of volatility by trading.

Washington is trying to bail out the whole US economy

We finally got the details about the US government's next bailout attempt...a $150 billion-plus package that will send rebate checks out to taxpayers and some more that will promote spending by businesses. It wasn't enough that the government tried to bail out people with irresponsible mortgages...or that the Federal Reserve continues to bail out Wall Street with cheap money by cutting interest rates and adding liquidity every time the stock market falls..or that foreign investors are bailing out US banks who didn't properly manage their risks. Now the government is in the business of bailing out the whole US economy!

Rather than address a single problem that the US has with its struggling economy, the government is just going to mail out checks equal to 1% of the US GDP. What better way to grow an economy than have the government spend money it doesn't have? Nobody's happy if the economy does not grow 6% per year and the stock market doesn't grow 10%.

Unfortunately, the band-aids keep getting bigger. And we all know that we use the biggest band-aid for the more serious scrapes and cuts. But there comes a point where band-aids don't help any more and you need serious medical attention to fix the problem.

The US economy is reaching the point where band-aids no longer work. The wounds are becoming infected underneath the band-aids. We need some significant work to fix our broken economy.

Ben Bernanke�s Economic Stimulus Package

Ben Bernanke is urging Congress to enact some sort of economic stimulus package, which most likely will come as tax rebates or unemployment benefits. The idea is to infuse about $150 billion into the economy by giving money to people to spend, trying to jump-start some consumption and job growth. While the idea will likely give a little boost to the overall GDP in 2008, it is about as useful as putting a Band-Aid over cancer. Let’s look at some of the results that will come from this stimulus:

• $150 billion in the US is a drop in the bucket when spread thinly. Very little in new investments will be made, creating few jobs.

• The stock market will artificially inflate temporarily, allowing executives to take more attractive bonuses. Eventually stock prices will fall back down and the gains will be lost.

• The US’s budget deficit will grow since the money will not create enough job growth to increase future tax dollars to the government.

• Very few individuals will be significantly affected by a few hundred dollars in their pocket. I can see most people going to Wal-Mart or the grocery store to spend their money. This won’t change anything significant in the economy.

What we need is a stimulus that will create sustained growth, not just a little “pop” in the economy. A cash infusion spread thinly will not create investment. Nor will tax breaks for corporations (which is being suggested by conservative economists). We need a stimulus that will promote the following:

• Increase overall consumption by spreading GDP dollars more evenly throughout the population (reduce the wealth gap)

• Increase productivity by promoting investment in technology and education

• Increase productivity by increasing the number of workers

• Increase productivity by improving the morale of the dejected US workforce

The solution? Put the $150 billion into the Small Business Administration in the form of grants to small businesses. If the SBA gave grants of $500K to qualified small businesses with promising plans for growth and invention, there would be 300,000 small businesses with a huge cash infusion. These businesses will spend this money on capital improvements, new employees, and investment that will boost productivity. The absolute worst that will happen is that the companies will spend the money on a failed business, creating no growth…but they will spend the money. The worst case scenario of this solution is the best case scenario of Bernanke and Bush’s stimulus plan.

Credit Card Crisis

The next crisis this country will face is a credit card crisis. Capital One just announced a charge of almost $2 billion for bad loans...I think this is just the beginning. Look for more write-offs as consumers continue to build up credit card debt with no increases in income and no home equity to cover the payments. These banks are much less willing to lower interest rates, which will make it harder for consumers to pay down balances. Add to this tighter regulations the banks have to follow, a weak economy, and we will start to see the fallout of this country's dependency on credit.

The Middle Class Crunch

I’ve been reading plenty of articles lately about the middle-class crunch, talking about how it is almost impossible for a middle-class family to make ends meet. The ones that really grab my attention are the ones written by economist that deny that a middle-class crunch exists. I see so many Wall Street economists read off macro-level data showing that the crunch is an illusion because inflation is x, health care is y and GDP growth is z, without ever looking at a real-life situation. You would think that these economists would be some of the more intelligent people who could conduct a simple income statement, considering that these are the ones driving the economics of our country’s financial system.

To show the reality of the middle-class crunch, I conducted a simple budget for an average couple living in Orlando, Florida. Only one member of the household is employed in this example to save on commuting costs (considering the cost of daycare, fuel, cars, etc., unless the spouse can attain a high salary, it is not worth it to have both partners working). This example shows the absolute bare-bones expenses of an average couple in Orlando who has not yet had children:

1.      They share one car, which was purchased in 2005 for $23,000 and financed over 6 years with 10% down and an APR near 8%.

2.      The commute to work is about 20 miles, and after running errands and other trips, fuel costs about $250 per month.

3.      A 6-month rate for Geico is around $600…it is this high because living a house below the median price for the county means you are living in a less than ideal neighborhood.

4.      Maintenance of $50 is conservative considering you need to change the oil every 3 months, routine maintenance, flat tires, dents, and all other things that go wrong with a car.

5.      Tolls of $0.50 per way on the commute for the each of the 20 work days, plus a few dollars for other travel on the highway.

6.      Very little per months on clothing. I didn’t even have to include this line, but it makes the example a little more realistic.

7.      Eating out once per week. It is difficult to eat out and buy one appetizer, two entrées, soft drinks and a tip and spend less than $35.

8.      Food prices are out of hand. Try to go to the grocery store and eat for a week and pay for laundry detergent, cleaning supplies, batteries, and all other small household necessities for less than $125. Keeping the monthly grocery bill under $500 per month is difficult.

9.      Maintaining a house costs money…there are always leaks, broken appliances, filters to change, yard upkeep, termite and pest control, and all other regular maintenance a house requires.

10. Purchasing a small, 3 bed, 2 bath house for $180,000 ($20,000 below Orlando’s median home price) and paid 20% down, leaving a mortgage of $144,000 at about 6%. After real estate taxes and homeowners insurance, the monthly payment is $1279.

11. A gym membership to work off the stress of not being able to make ends meet is $21 for the couple at Planet Fitness.

12. Two small dogs or one big one that eat 12 cans and one bag of food per month. Add in vet bills and heartworm pills and $30 per month is very conservative.

13. The house has a cable and internet package from Brighthouse.

14. Being very economical keeps the electric bill at about $200 per month.

15. A family plan from T-Mobile costs about $80 per month, plus a land line that is required for the alarm system.

16. A home security system that costs $27 per month, because as previously stated, a house at this price is not in the best neighborhood.

17. The water and sewer bill averages $85 per month.

This is a no-frill budget, leaving out many expenses that many people incur This is the budget of a couple with no children living at bare-bones costs in a below-average house and sharing one car. This list includes absolutely no entertainment other than cable TV and eating out a few times with no savings for the future. Does this sound middle-class to you? With these expenses totaling over $3400 per month, living in this situation would require a salary of about $59,000 per year assuming taxes and benefits take 30% off gross income. Throw in children and this monthly cost goes through the roof. Now try to find a job in Orlando that pays $59,000. These are management positions that require significant education and experience. You need a college degree and 3-5 years of experience. Consider that every additional $100 per month expense would require $1714 of added income, living in the middle class today becomes almost impossible. Forget about gifts for Christmas and birthdays, flowers for your mothers on Mother’s Day, a new computer when your old one breaks, or a new sofa after the dogs scratch up the old one, or any other luxury. Let’s just hope this middle class couple doesn’t ever get a cavity, need braces, have a car accident, get sick, or have a baby. Welcome to Middle-Class America, where according to some economists there is no crunch.

Tootsie Roll Industries, Inc. - How Many Licks?

How many licks does it take to understand why the share price does not grow at Tootsie Roll Industries? Let’s see how many…

Melvin and Ellen Gordon hold about 16 million shares of TR, nearly 30% of the total outstanding. Major change is unlikely when these two control the executive decisions of the company, the board, and the shareholder votes. There is virtually no system of checks and balances to ensure that the company is operating with the stakeholders’ interests in mind. The only stakeholders who are being interests are being met are the Gordon’s.

Executive compensation has virtually no performance incentives. Pay is split between a base salary (which is excessive) and a bonus based on management’s discretion. Each of the key executives makes over $1 million in salaries and bonuses, with no compensation based on share performance (meaning no stock options). Share price and company growth are not a priority at the company.

Excluding the Gordons, senior management holds a total of 35,403 shares, totaling less than $1 million in a company worth $1.42 billion. The total ownership by senior management is less than any single executive made in salary + bonus last year. Why do they care if shares never increase if they don’t own any?

When was the last time you saw a new Tootsie Roll product? They like to purchase dated candy companies that have no relevance in today’s society, like Andes Candies and Double Bubble. Purchases of these companies provide no growth, if not negative growth.

According to the annual report, “the Company does not expend material amounts of money on research or development activities.” How do they expect to grow? Oh yeah, I forgot, growth does not benefit management in any way.

The Corporate Governance Quotient is a corporate governance rating system provided by Institutional Shareholder Services (ISS) on over 8,000 companies worldwide that evaluates the strengths, deficiencies, and risks of a company's corporate governance practices and board of directors. Tootsie Roll Industries has a Corporate Governance Quotient better than 0.5% of the S&P 400 companies. Doing the math, that means that there are only 2 companies worse than Tootsie Roll in the S&P 400 in terms of corporate governance.

My New Years Resolution - A Portfolio Overhaul

In 2008 I am overhauling my portfolio. By the end of January I expect to have a beautifully streamlined portfolio that is poised to maximize my potential return. I am doing this because as time goes by, my portfolio tends to get out of control. I have too many different securities, too many companies that are not in position to grow, and too many investments that veer off track of my goals and time horizon. I also want to align my holding with my updated views of the market and the future of the market, and allow me to be more flexible to realign my positions.

I sold nearly all of my large caps, and going forward my large-cap holdings will almost exclusively be held in ETFs. I do not like to be a stock picker of large caps because it is too difficult. Large caps are very liquid and over exposed. These two qualities in my mind lead to high efficiency in pricing and an inability to beat the overall market. Also, the stories are already played out. Wal-Mart is not likely going to double in size in the next three to five years. I see investing in large caps as trying to time markets and cycles, not investing in the fundamentals of a company. What would be an exception to this? I continue to hold ExxonMobil. I am investing in ExxonMobil for the play on oil, not for the company itself. If oil prices continue to increase, my investment should follow. If oil prices fall, my investment probably will also fall, but I’m making up for it by paying less to fill up my tank! I am essentially hedging my commute!

I am getting out of Brazil. Brazilian stocks have had an incredible run in the past 4 years, but I am beginning to wonder how much higher they can go. Until 2004, Unibanco has hovered around $20 per share. It now trades over $140, even though sales and profits have not even come close to that growth. Signs are also starting to point to the dollar reversing its fall, meaning the real should start to fall vs. the dollar. I’m going to take my profits from Brazil and run. I may be bailing out too soon, but I don’t want to get greedy in a country with such a shaky economic history.

I will use ETFs to capitalize on some sectors getting beat up more than they deserved. This includes financials and residential real estate. When I am comfortable that both of these sectors have reached their bottom, I will be purchasing XLF and REZ shares.

Gold…this is a tricky one. Gold is often used as a hedge against the dollar falling and against inflation rising, so its price has historically tracked the inverse of the dollar. I believe that the price of the dollar already reflects the weak US economy and the upcoming interest rate cuts, and I am expecting a slight recovery of the dollar. Based on this logic, gold prices should fall accordingly. However, I don’t know if that will happen. I think that gold is becoming the next hot investment that everybody wants to buy, currently priced at $862 per ounce and triple what it was in 2001. It looks like this price will continue to increase, but I’m not going to fall into the trap.

So what will my stock portfolio look like? After the overhaul, it will likely have about 4 or 5 different ETFs, comprising about 40% of my portfolio, to diversify my holdings. The other 60% will be held in mostly mid-caps that I feel have the potential to someday become large caps and small caps that can become mid caps…maybe 15 to 20 different holdings.

Anthracite Capital - AHR

I will be adding more shares of AHR to my personal portfolio, which is already my largest holding. This is my all-time favorite stock, and is very cheap now below $8. Let’s look at the fundamentals: Anthracite Capital is a REIT that invests in mortgage-backed securities. Hold on now…after all the turmoil lately, why am I buying a company that invests in mortgage-backed securities? Because AHR invests only in commercial MBS’s…which typically hold much lower risk of major defaults. It holds little to no residential securities. From its EDGAR filing, about 30% of its holdings are in non-US retail, 22% in non-US office, and 16% in US multifamily CMBS’s.

Priced below $8, this stock is paying a dividend above 14%, so right off the bat you are getting a huge return. It has a P/E of 5.5, earning $1.40 per share. Because it is classified as a REIT, it must pay out 90% of its earnings, so it is currently paying out $1.20. They continue to grow revenues, which will likely lead to higher earnings, dividends, and share price. So I see three ways that this investment will pay you…the 14+% in dividends, capital growth based on its revenue growth, and increases in the dividend amount as profits grow.

How about cash? Yes…positive operating and net cash flows, growing significantly in the past three years. Insider buying? They’re going nuts over there with this low price…9 purchases vs. 0 sales in the past six months.

What about the risks? I think shares can stay low for a while until investors realize that the mortgage mess is limited to residential. As I said before, I don’t foresee major defaults in CMBS. Commercial is a much more responsible environment than residential. Otherwise, this company is managed well and likely to continue to reward its shareholders for a long time.

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The mania era

Now that we're in the middle of the housing market downfall, I'm just now starting to wonder what the next mania will be. After the collapse of the dot-com bubble, you would think that we as a country would learn to show a little bit of restraint with our investments. That did not happen. What happened is that some people started to make good money with real estate. Then you had the followers, then more followers. Suddenly, you had real estate professionals in half of the SUVs at every intersection with window letters promising to make me rich with real estate. Then the suckers who believed the SUV drivers and were the last to enter the real estate market. By this time, the leaders and the first several groups of followers got out, and the suckers are the ones that now can't give away their real estate holdings. This is exactly what happened with internet stocks, if you didn't already forget 1999 when your co-workers, hair stylist and plumber were touting pets.com.

So why does this continue to happen? We're a get-rich-quick society. That is not a bad thing, because this is the foundation of the United States' greatness. This culture creates winners and losers, and it creates manias like the dot-com and real estate bubbles. We all want to get rich quickly and easily, and when we see others getting rich, we think that we can do it also. What many people do not realize is that the people making the most money are the ones that get in before the mania begins, and get out before the mania reaches its peak.

Nobody wants to be the loser of the mania...the last one in that buys at the peak. So how do you win from this mania economy? First and foremost, don't be the loser. Don't be the one that gets in when we are in the midst (near the peak) of a mania. If your co-workers (unless you work at Berkshire Hathaway), plumbers and hair stylists are talking about the market, don't buy. If you see SUVs and signs on the street corners talking about how to make money in a particular market, get out or don't buy. Better yet, start looking at short positions to take advantage of the upcoming downfall. You can bet on a downfall because when regular people are already in the market, there's no money left. A market can't grow without money ,and don't bet on anybody else coming out of the woodwork to drive the market higher.

Another way to make money is to pick up the scraps after the collapse. Manias don't just go up. When a bubble collapses, everything comes down. There are casualties of collapses that are not justified. After the dot-com mania, you could have bought Yahoo for less than $5 per share or Western Digital for $2. With the real estate market collapsing, start to look for foreclosures or even houses with owners desperate to sell. Start looking at homebuilders or responsible mortgage lenders who with strong balance sheets and cash flows who will weather the storm.

The winners are the ones who take advantage of the followers, so don't be a follower. And make sure you look for trends early. And the most important lesson of all...absolutely do not over-leverage yourself to get into the market. This is what creates manias.

Take your losses, trade up

We're just about at the end of 2007, so it's time to put a little thought about the day coming up in April when you have to prepare your tax return. Most of us don't like to think about this until at least March, but now is you last chance to take some actions to reduce the amount you have to pay later (or increase your refund). Although taxes should not be a reason to sell a stock, the end of the year can give you an opportunity to improve your portfolio and realize some capital losses to offset gains (Keep in mind that this advice is for investors, not traders. Traders who treat their trading as a business work under a different set of tax rules than a normal investor).

If you sell a position to realize a capital loss, the IRS does not allow you to claim that loss if you purchase that same position within 30 days. you can wait 31 days and buy again, but much can happen in those 30 days. You may be leaving potential gains behind by closing your position in the investment. so what are your alternatives? One option is to buy a similar investment, and potentially a better investment.

Suppose you purchased some shares of Citigroup last December when it was trading around $55. By now, you're holding a loss of about $15 per share of a company that is experiencing some executive turmoil and seems to be making some poor decisions with its operations. Rather than continuing to hold a loser, you can sell your Citigroup shares and buy shares of a similar investment...for example JP Morgan Chase or Deutsche Bank. This way, you still hold a position in a major money center bank, you can claim your tax loss, and you now hold shares in a company that may be better positioned to provide you capital gains in the future - 3 wins after a year of losing.

Stop the Bailouts

Like many people, I am opposed to the bailout of ARM borrowers proposed by President Bush. Not because it is not fair and that people should suffer from their poor decisions. Well, I do believe that people that take risks need to understand that often times the risk does not pay off. But that is not why I oppose this plan. I oppose the plan because of the consequences that the bailout will create. It is simple for the government to pass a bill that will force banks to freeze the interest rates on ARMs for a period of time to help the borrowers. What is not simple is dealing with the repercussions of this freeze.

A quick tutorial on mortgages:

Every transaction has at least two parties. A mortgage has several. The bank enters into an agreement with the borrower to loan money at a particular interest rate. The bank loans the money to be paid back in the future with interest. So how does the bank get its money to pay the borrower? It borrows from people that want to save and invest money, and pays these people interest on the money they invest. The bank makes its money by paying investors lower interest than the borrowers pay the bank. But the bank does not want to deal with the risk that the person may not pay back the loan. In addition, the bank does not want to take on the risk that a change in interest rates will leave them paying more to the investors than it makes from borrowers. So what does a bank do to reduce these risks? One way it reduces these risks is to "swap" the borrowers mortgage and interest payments with another entity. With a swap, this other entity pays the bank a payment and interest (perhaps a fixed interest rate) in exchange for the adjustable rate that the bank receives from the borrowers.

Another way to reduce risks is to create a type of investment (Mortgage Backed Security) that allows the investors to assume the risks that the borrower may default on their mortgage (or pay their mortgage early, which is another risk of a mortgage). The bank or other financial institution then sells these investments to investors willing to assume the risk that the bank does not want to assume.

The consequences of the bailout:

So what does the bailout have to do with all of this? Many intelligent investors recognized that there were too many people taking mortgages that they would not be able to pay in the future. They took positions in mortgage backed securities that would pay off when people who took risky loans eventually defaulted. With the bailout, these investors that made the correct decision will not reap the benefits of their foresight.

The consequence that the economy will suffer is the loss of confidence in various types of investments. Why would you invest money in a security when there is a chance that the government will step in to reduce your profit? Loss of confidence leads to less investment in the markets, leading to a decline in the market. A decline will reduce the amount of money banks can lend to other borrowers looking to purchase a house with a mortgage, reducing the potential profits of the banks (and investors in banks).

I can continue down the line of all of those who will suffer negative consequences of bailouts, since it affects all of us. Money is never free, so somebody has to pay for those being bailed out. The problem is that the bailout will only postpone the problems of the perhaps 250,000 borrowers in trouble. But you can rest assured that the total cost to the economy from the bailout will far exceed the benefits to these borrowers. In the end, all of us will be paying dearly to help these borrowers who made a poor decision.

Demographic Trends

Demographic trends to look for in the next decade:

With Baby Boomers retiring and leaving the workforce, there will be a major shift of power and pay to the younger workers. This is the market force that is needed to help correct the imbalance of pay in the US. It is unlikely that any regulations will be imposed to limit salaries of executives of public companies, so the market itself must correct this inefficiency. Many argue that these exorbitant salaries are determined by the market, but what this argument does not consider is the level of efficiency in this market. A market is only efficient when there is significant visibility and liquidity. The market for executive talent has neither of these qualities. Unless executive recruiting and salary determination somehow incorporate these qualities, some outside force will need to intervene to avoid a continuation of this inefficiency and to avoid other detrimental side effects. Some are looking to the government or other regulatory body will be this outside force. I see that as unlikely, and believe that a demographic shift is more likely to drive the change.

We will open our doors to the rest of the world. A heated debate continues regarding immigration and who we allow to enter this country to work, but there will be a severe shortage of workers if we continue to filter immigrants at the current level. This will come to light with the baby boomers’ exodus from the workforce. Real GDP growth has been tapering off since 2000, and I expect the trend to continue. The current scapegoats of the slowing economy are the War in Iraq and oil prices. What is escaping attention is the continued decline in the growth of the labor force. GDP is a measure of our country’s income. Real GDP can grow only when the country produces more goods and services than the prior period. This can happen only when the current workers become more productive, or when there are more workers that can produce. I’m sure that many people will agree that the current workforce is stretched close to its capacity in terms of productivity. We had significant economic gains when women entered the workplace in large numbers, but we have been at about 59% participation of women in the workplace since its peak in 2001. Male participation has fallen to 73% (it was at 87% in 1948 and 78% in 1975). Unless we put our children to work, or figure out how to become more productive, we have to open our doors to outside workers if we want to grow our economy.

The housing market will be stagnant for many years. The housing market is another force that can grow with either more people or the same people buying more. The housing boom of the early and mid 2000’s was primarily driven by people buying more houses. There were not more people entering the country buying houses, but more people already here buying houses. It inflated to a point where not only a larger percentage of the population became homeowners, but existing homeowners were buying second and third houses as investments. Prices inflated to the point of becoming unaffordable, and we are now seeing the results. Very few areas of the country have median incomes that support median home prices. With income growth very slow for low to middle class Americans, it will take years before incomes catch up with housing prices. Once we start to see median income levels increase steadily (see bullet 1), we will not see significant housing price increases.

The Monopoly Economy

For most of us, our first economics lesson began when we were young children, playing the game of Monopoly. As the shoe, the hat, the cannon, or the car, we learned some of the most valuable lessons about economics and capitalism. Today, we’re going to review those lessons, and look into what we’ve forgotten and what we in the US never learned as a country.

When one person has all of the properties, all others in the game go broke and the game ends. Our economy is moving towards that point. We have very few people making all of the money, moving closer to the end of the game. Owning a house on Baltic will not help when you have to pay $1500 every time you land on a Park Place Hotel. Eventually you will have to foreclose and sell Baltic to the winning player.

The players that get ahead quickly in the game usually do so by Chance (or Community Chest), or by luckily landing on Free Parking. Success in the beginning is not normally determined by skill. The lucky players catch a break and collect sums of money. The good players separate themselves from the bad by how they invest the money they collect. Bill Gates took a Chance when he purchased an unknown computer operating system. He won the Monopoly game because of how he took advantage of that Chance, since everybody reading this article landed on his property and paid rent.

You need to invest to survive. Everybody in the game passes Go and collects their $200, but you will lose quickly if you just collect your $200 and continue to pay rent on every turn you take. Even if you get lucky a few times and land on Free Parking, you will give your money back to the players who own properties. In the real world, if you do not own a money-making investment, you will eventually go broke. Simply earning a paycheck and spending it will never allow you to get ahead. The people that get ahead are the ones that own assets that return money, and the ones that get the farthest ahead own more assets and better returning assets (like the yellow, green and dark blue properties).

Once all of the money is gone from the bank, the only way to get more is to win it from another player.

The game is not fair and doesn’t work if the bankers’ friends let the banker collect all of the money, even if the banker is bad at Monopoly (see Charles Prince, Stanley O'Neal, fill in the blank with your favorite overpaid executive who made poor decisions).

The game would not be fair if the rules stated that if the player who is winning the game makes a bad decision and loses most of his money, he is bailed out by the bank. This rule would not apply to a player who is not winning.

Illegal Immigration Was one of the Drivers of the Late '90's Economic Boom

The big debate in this country now revolves around immigration reform. Everybody admits that illegal immigration is a problem, but how big of a problem? Not too big, if congress can put it on the back burner. Why? Because illegal immigration is good for the economy. It was one of the drivers of the boom of the '90's. Computers and the internet get most of the credit, but adding millions of cheap employees to the workplace only helps corporate profits.

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If a company is willing to pay an employee - any employee, not just the cheap illegal ones - that company is earning much more than it is paying the employee. Not only does the employer benefit with greater profits, but the employee needs to consume to be able to live here. So when an illegal immigrant enters this country, they need to consume at least the basic necessities - food, housing, clothing, transportation - this creates demand for these goods. Employers need to hire to meet this demand, so they hire this cheap, illegal immigrant. For every hour this immigrant works, the company makes $15 and pays the immigrant $6.00 (numbers are not actual figures...just examples). This immigrant in turn sends $2.00 back to their country and spends the $4.00 in basic necessities.

So for this one hour worked in the US, the home country of this immigrant gained $2, the employer gained $9, and $4 is recirculated into the US economy as consumption.

Unfortunately, the medial likes to focus on the $0.25 of costs of this example that the immigrant imposes on the government, creating another round of hatred for immigrants on this country.

Excessive Executive Compensation is Driving Economic Failure

The subject of executive compensation gets everybody frustrated, because we all see the executives in our companies making millions of dollars while we struggle to pay for gas and groceries. But the problem runs deeper than our personal frustration...I credit corporate greed as the primary cause of many of the recent economic difficulties. Our economy needs consumption to grow. If people do not spend money, the economy cannot grow. We all hear how we need the excessively rich people to spend on luxury items to help grow the economy. I think this completely misleading and biased. Why? Because this is not optimizing consumption. If you made just enough money to pay the bills, you are going to spend every dime of your income immediately…100% consumption. If you make a hundred thousand dollars per month, you’re most likely going to put a big chunk of that money off to the side in an investment or savings account…not even close to 100% consumption.

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When the average American is spending more than 100% of his income on day-to-day living (2005 marked the first year since the Great Depression that Americans spent more than they earned, and with the housing boom flowing into 2006, that trend will likely continue), you can rest assured that the top 1% of this country's earners are not spending even close to that percentage of their income. Much of the 20% of the country's total income that the top 1% of the workforce is earning is not going back into the economy as consumption dollars.

I am not saying that people should not be able to become rich. Capitalism does not work if people cannot get rich. What I am saying is that a person should become rich by creating something of value. It should be earned. When you create value you improve the conditions of others, and many people benefit. 1) Jobs are created 2) consumers gain a valuable product 3) the economy grows 4) the owners become rich from the profits. This is how Capitalism should work.

The catch is that Capitalism works best in efficient markets. There are certain areas that do not allow for efficiency, requiring outside (government) intervention. This is why we need government programs such as the military, infrastructure, and firefighting. I feel that the labor commodity is an inefficient market as well. I do not think that the government should intervene, as it does by supporting a military, etc., but I think that we need to push for a more efficient labor market. So how do we solve the problem of excessive compensation? We take steps to make the labor market more liquid and transparent. We find the barriers to efficiency and create products and services that break these barriers. So what are the barriers to labor market efficiency and how can we solve them?

One barrier is imperfect information. The job market is highly inefficient with pricing power heavily weighted toward employers. Salaries are set based on the lowest amount a candidate is willing to accept. Most people are not aware of average salaries for their position or what they should expect to aid in negotiations. More visibility will only provide tools for the labor market to negotiate with employers. More tools are becoming available, but they are still not widely used or applied because of the extreme confidentiality of employers. Employers are not willing to classify job openings to allow candidates to compare the position with average salaries.

Another inefficient process is the compensation setting for executives. Compensation is set by committees or consulting firms with severe conflicts of interest, when the market should be setting the compensation for executives as it does for lower-level positions.