Charter Trust - Global Market Update

The Triumph of the Engineers - Was Superstorm Sandy a wake-up call? At their peak, flood-waters from Sandy crested in New York City at 14 feet above normal, leaving thousands homeless and millions without power. The damages may total over $40 billion dollars. Many are asking whether it is possible to adapt to increased storm risks due to rising sea levels and increasing urban density. The experiences of other coastal cities may prove instructive as city planners seek to adapt. For decades countries have built storm barriers to protect against a storm surge. This brute-force approach is simple: keep the water out. In England, the Thames River has massive storm barriers that have been closed 75 times in the past 10 years. Venice has a series of underwater gates that can be raised to isolate the Venetian lagoon from the Adriatic Sea.But these approaches can be overwhelmed by higher sea levels. Rather than keeping water out, some cities are finding ways to ride out the rising storms.The Dutch have experimented by building floating houses. Some homes rise up to 20 feet, riding on buoyant hollow concrete foundations, while moored in place. They have their utilities—electricity, water, sewer—provided via flexible, hollow pipes. In Japan, urban engineers have burrowed deep under Tokyo to construct nine huge subterranean reservoirs, along with 15 massive catch-basins at street level that double as parks and stadiums during normal times.These adaptations continue the tradition of engineering solutions to environmental problems—something we’ve been doing for millennia. It’s a testimony to human ingenuity—and to nature’s continuing challenges.

A Tipping Point? - What good is college? A college degree from a selective four-year private school costs families around $240 thousand dollars, give or take. There’s literature out showing that lifetime earnings of college graduates are higher than non-graduates, but it’s unclear how much of that advantage is inherent in the education itself, and how much is signaling: the degree becomes a marker, shorthand for “this person is intelligent and/or diligent enough to obtain admission and complete the curriculum at U of X.” But there is a significant disconnect between the content of what people study in college and what they do in their commercial lives. The cell biology class I took my junior year seems particularly irrelevant to my work as a financial analyst. So is that time and money wasted? Some people think it is. That’s why college completion rates are so low. Federal statistics indicate that just a little more than a third of all enrollees graduate from four-year schools (although that number is much higher highly selective institutions). If the classes seem irrelevant and it takes so long that life gets in the way, why spend the time and money? Still, college is a way for young people to develop habits of mind, patterns of life, and social skills and connections that will enable them to be life-long learners and prepare themselves for tomorrow’s economy. But the price tag makes it impossible now for middle-class kids to “work their way through school” as some did in the past. If a four-year residential degree is to be anything but a marker of privilege, schools had better cut their costs. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

No Little People? - Where have all the small IPOs gone?One of the unfortunate side-effects of the financial crisis has been the consolidation of the financial sector, especially brokerage firms. When Merrill Lynch, Bear Stearns, or National City got in trouble, they were merged into Bank of America, JP Morgan, and PNC. Other firms, like Lehman Brothers, just went away. The too-big-to-fail banks became even bigger.This has had an impact on the initial public offering (IPO) market. Everyone loves to discuss mega-IPOs like Facebook, which raised $14 billion, or Dunkin Donuts, which raised $400 million. In order to have an impact on their earnings, the big banks compete to manage these big IPOs. This creates huge demand for huge deals, with potential for huge stumbles, like Facebook.But these high-profile companies don’t really need brokerage firms to manage their public offerings. Everyone knew about Facebook and Dunkin Donuts. They could have gone public via an auction process, as Google did in 2004. They raised $1.7 billion cutting out much of Wall Street—a record at the time. But it’s small firms that need the expertise and exposure that major dealers can provide.Some very famous firms started small: Intel raised only $7 million in its IPO; Microsoft raised $30 million. These firms didn’t need the cash, but they did need the liquidity. They needed to be public companies so they could use their own stock to compensate employees and make acquisitions. And they needed advisors to help them tell their stories to the institutional investors who can make or break a small IPO.But there is little virtue in being small today. With mega-firms competing for mega-IPOs, at least in finance today, small is not beautiful.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

New Kid on the BlockThe British Prime Minister just selected the head of Canada’s central bank to run the 314 year-old Bank of England. What does it mean?Mark Carney is a 47 year-old Harvard undergrad, Oxford Ph.D. (in Economics) who spent 13 years managing sovereign credit risk for Goldman Sachs before serving as a Deputy Governor, and later Governor, of the Bank of Canada, beginning in 2003. He served the Bank of Canada well, lowering rates in March of 2008—rightly judging that the leveraged sub-prime loan crisis in the US would trigger global financial contagion. Later he made a conditional commitment to keep rates low for a least a year—boosting confidence. He later raised rates, in 2010, moving back towards a more normal stance.The Bank of Canada didn’t undertake quantitative easing, and hasn’t dramatically expanded its balance sheet. It didn’t need to. Rising oil prices have stimulated Canada’s economy far more than low interest rates. The country is the 5th largest oil producer in the world, producing 3.6 million barrels per day and exporting about a third of that. At $80 / barrel, that’s $40 billion of stimulus a year.Carney will find the UK economy far different: 40% larger than Canada’s, far more diversified, with a much larger public sector and stubbornly slow growth. Indeed, England is just emerging from a double-dip recession. It also has a weak banking sector and several “too big to fail” institutions. Canada is notable for the lack of drama from its banking sector during the crisis.Carney has the reputation of an insightful economist who is willing to experiment. If he succeeds in reigning in the banks and finding innovative ways to stimulate the British economy, maybe we can lend-lease him back here when Bernanke’s term is up. Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Short-Term MemoriesRemember Auction Rate Preferred notes? These investments seemed to offer something for nothing. Their interest rate would float at a spread above LIBOR and be reset weekly. If investors wanted their money back, there were supposedly a host of other investors ready to purchase the securities at their next auction.But it didn’t work out that way. When the financial crisis hit, a lot of the auctions failed. Short-term notes became long-term loans. Bonds that were as good as cash suddenly traded at a deep discount. Borrowers were unhappy, too. Their weekly-reset cash-like interest rates suddenly went to penalty levels four or five percent above the benchmark. That was bad. but it got worse: many of these credits were municipalities that had swapped their floating rate liabilities into fixed rate exposure. These “pay-fixed, receive-floating” interest rate swaps were now bleeding cash, even as the towns needed to pay more to their bondholders.So we had angry bondholders and angry borrowers. Naturally, they sued the brokers who set up this process. At first the brokers claimed that failed auctions hadn’t happened before, so they couldn’t be held responsible. Only they had: in 1990, Citibank and some small utilities got into trouble when their preferred auctions failed. The brokers should have known better.So many brokers bought the discounted bonds back at par, bailing the investors out. Swap counterparties also settled for pennies on the dollar, as cash-strapped municipalities cancelled swap contracts. This “sure thing” backfired for everyone involved.Some of the lawsuits are finally being adjudicated, and it isn’t going well for the dealers. This disastrous product was sold to unwary investors because many were reaching for yield, which often ends in tears. While this particular chapter remains closed, today’s yield-hungry investors should be on the watch for products like these. Let’s not forget the foolishness of the past, lest we repeat these kinds of mistakes in the future. We don’t need any more tears.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Another Black Swan? - Is the world a fragile place?That’s what Nassim Taleb thinks. The former best-selling author and hedge fund manager has written a book in which he divides the world’s structures into three categories—the fragile, the robust, and the anti-fragile. Fragile items are those that are getting along, but break down in times of stress. Robust items can stand up to shocks and stresses without changing. Anti-fragile systems get stronger and more creative when they face new challenges.Taleb has been thinking about these things for a while. His first two books, Fooled by Randomness and The Black Swan dealt with disasters like hundred-year floods that seem to come around every decade or so, or stock market crashes that feed on themselves. In mathematical parlance, they have “fat tails” in their distribution: highly improbable events that happen more often than they should.Taleb has now graduated from financial trader and hedge fund manager to self-styled philosopher and lifestyle guru. In his earlier works he focused on the failures of economists and financial managers to fully understand the game that they were playing. His ideas seemed to be validated by the Financial Crisis of 2008. But his rubric of fragile, robust, and anti-fragile is facile and unconvincing.For example, he claims that drinking a small amount of tap-water from India every year to expose your body to their toxins and germs will make it stronger. But where is the evidence? Are Indian citizens healthier, on average, than Europeans and Americans? Or his anti-fragile advice for modern states is to completely avoid debt, because “when you don’t have debt you don’t care about your reputation, and when you don’t care about your reputation you tend to have a good one.” But this is nonsense. There were times in US history when we had little or no debt and no central bank, and our economy and politics were just as volatile and vitriolic as today.For every complex problem there is a solution that is simple, intuitive, and wrong. Taleb’s anti-fragility hand-wavings appeal to those looking for simplistic approaches to complex problems. But his self-referential Deep Thoughts remind me of a college sophomore criticizing Plato: too glib for his own good.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Giving Thanks - So what do you have to be thankful for? I thought about this question and a lot of things stand out:First, I’m thankful that the election is over. As a proud resident of a “battleground” state, my land-line phone rang nonstop during this election season. I’m thankful that our family can eat a meal in peace.I’m thankful that New Hampshire has no major-league sports teams: so we don’t have team-owners threatening to move their franchise if we don’t build them a new stadium. Miami Marlins fans just had to watch owner Jeffrey Loria trade away proven players for unknown prospects after they built a $515 million stadium in 2008, complete with 37,000 seats and a retractable roof. Taxpayers are on the hook for this white elephant, even though the team finished 12 games below .500 last year.I’m thankful that Apple and Samsung both have killer smart-phones. Competition is what makes things better for consumers. Competition means I can buy jeans for less than $10 and a snack-wrap for $1.40. Competition means computers just get smaller, lighter, and cheaper. Are you listening, guys? It’s your innovation, not your lawsuits, that’s changing the world.I’m thankful that amidst cheaper energy, a stronger housing market, and low inflation and interest rates, the economy is growing. A growing economy provides opportunities for young and old alike, to better themselves, to be what they want to be, and to earn a living while doing it.Most of all I’m thankful that the turkey’s in the oven, my kids are coming home, and the holidays are giving me a few days to reflect on what’s really important.Happy Thanksgiving, from Charter Trust.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Down the Drain? - Sometimes the end isn’t the end.With potential buyers lining up, Bankruptcy Judge Robert Drain sent the baker’s union and management back to the negotiating table. The union thought that management’s threat to go to liquidation was a bluff, that there were would be a white knight behind them to rescue the company if they just held out long enough. But when they began to make liquidation plans in earnest, the union may have had second thoughts. So the Judge is giving them one last chance.If they can’t come to terms, there are at least three potential buyers. Grupo Bimbo (No, I am not making that name up) is based out of Mexico and is the world’s largest bread-baking company. They own Entenmann’s, Thomas’s English Muffins, and a host of Latin American brands. Flowers Foods used to make Mrs. Smith’s Pies and Keebler’sCookies, but now produces Roman Meal, Sunbeam, and the Nature’s Own brands. Finally, there’s a private equity firm, Sun Partners, which claims that they could assemble a better deal for the union than Hostess, and still be cash flow positive in year one: that by investing in new technology, they could see a positive impact on the product, the people, and the profitability.The Hostess brand is iconic. For all the jokes about Twinkies surviving a nuclear holocaust, people buy them by the millions because they like having a sweet, light snack. In spite of all the faddish lo-carb, no-fat, zero-sugar diets, people indulge because, hey, it’s easy. But having a popular product is one thing. Producing, distributing, and selling it profitably is another.There are all kinds of reasons for unions not to trust management. But if the money’s not there, it’s not there. If this team can’t save the Twinkie, they really are Ding-dongs. Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

 Twinkie-Town - Should you stock up on Ding-dongs?On Friday Hostess Brands’ baker’s union rejected a proposed set of wage and pension cuts, forcing management to move from a Chapter 11 bankruptcy reorganization to a Chapter 7 liquidation. Consumers went out and immediately stocked up on the four major food groups: fruit pies, Twinkies, Ho-hos, and Wonder Bread. But they needn’t worry: the iconic brands will be purchased by someone, and will be produced somewhere. But it’s unlikely that the new own owners will hire the same workers from the same union at the same or better wages. Instead, whoever buys these brands will likely set up new plants in new locations with new contracts. There are a lot of states where unemployment is over 10% with a lot of people looking for work. Twinkies aren’t going to just disappear. Rather, they will be in short supply for a few weeks, and once new distribution channels are established, they’ll be back on the shelves What happens to the workers is another story. It’s not just an issue of greedy unions and inept management, as some on the right or left would have you believe. Hostess actually entered bankruptcy back in 2004 and was there until 2009. But they came out at perhaps the worst possible time: just after the longest and deepest economic slump since World War II—not exactly propitious for a snack-food company.And in addition to poor timing and high wages, the company had an antiquated distribution system and a relatively long inventory cycle. Cash-flow was a problem. A new company with new contracts and new management should be able to create value from a well-established brand.But some people will lose out. Herein lies the paradox of creative destruction: society cannot reap the rewards of competition without suffering the slings and arrows of fortune. That’s why we have a safety-net: to cushion the blow to individuals and families, while everyone adjusts to continual change.  Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Syrian Rebels - Arabs, and Persians, and Turks. That’s the key to understanding what’s going on in Syria. The country has 22 million residents has been ruled by the Assad family for over 40 years. From the rise of Islam in the 7th century until the World War 1, the country has been ruled by the Arab, Persian, and Turkish empires, successively, with brief periods under Crusaders and Mongols. But now these powers are vying for control of Syria again. The Arabs of Saudi Arabia, the Persians of Iran, and Turkey are all interested in what happens to Syria, both because of its modest oil production and because of its strategic position near Israel. The capital city of Damascus, with 1.7 million residents, is also a holy city in Islam. Since shortly after the Arab Spring, Syria has been in a civil war, with perhaps 50 people thousand killed and up 350 thousand refugees. The larger world powers have left the stage: Europe is broke and has no desire for empire; Russia can’t project its former Soviet-era strength; China is too risk-averse to get involved; and the US is out of the picture. So with the global policemen abandoning the beat, the neighborhood has been left to the strongest families to determine who’s in charge. And the three Islamic peoples representing three different modes of governance are deeply interested in how the civil war is resolved: Saudi Arabia a Sunni Arab monarchy; Iran and Shiite Persian theocracy; and Turkey a secular Islamic state with an independent military. All three had been empires in their own right, and all three have allies in Syria. So don’t expect this to end quickly or easily. Even if Assad falls, the rebels are likely to fight bitterly among themselves. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

Debt and Taxes - Can we forgive our way back to prosperity?Imagine this: you’re underwater on your mortgage and out of a job. You’ve been struggling to make payments on your home, but you’re not sure you can make it. You’re considering a short-sale and other options. Then you get a notice from a group called “Rolling Jubilee” that they have purchased your mortgage and forgiven it. You’d be delirious, right?Well, maybe. Because that lovely act—debt forgiveness—is a taxable event. That is, forgiving a $200 thousand mortgage creates taxable income of $200 thousand. This group solicits tax-free donations, buys troubled debt at a discount, and forgives the loans. They maintain that they’re not making any money from the debt cancellation, so they don’t need to file any paperwork. But the IRS may have a different take.Because when a bank takes a loss a loan, they deduct that loss as a business expense. Any subsequent recovery is income. It makes no difference whether that recovery is earned by a hedge fund speculating or by a homeowner who is unexpectedly mortgage-free. Debt forgiveness is income. Otherwise we could have our employers make “loans” to us every paycheck and then “forgive” the loans. Cute, but wrong .But you’d happily exchange a $200 thousand debt to a bank for a $56 thousand debt to the IRS, right? Again, maybe. The IRS has a lot more collection muscle than Bank of America. And tax obligations typically survive the bankruptcy process. Which brings up my final point: we already have a perfectly fine debt-forgiveness process. It’s called bankruptcy. It’s legal, orderly, and doesn’t create new tax obligations. Well-meaning but misinformed folks like Rolling Jubilee need to do their homework. Because the Devil—or in this case, the IRS—is in the details.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Un-Lockeing the Morality of MarketsJohn Locke is usually remembered as a source for the Declaration of Independence. But in a small pamphlet written in 1660 he also displays a keen sense of economic justice.In 17th-century Europe the price of wheat would vary by town. What was available in one city might be scarce in another. Locke noted two towns—one where the price was five shillings a bushel, and another where the price was 20 shillings, where there practically a famine. If it costs me the same to transport the grain to either town, which should I ship to and what should I charge?The answer seems obvious to us: the 20-shilling town, and we should charge the market price. Not only do we maximize our own profit, but we help avert starvation. But is it moral to sell grain for twenty shillings, when it would only bear a 5-shilling price somewhere else?Locke says yes, because not only are we satisfying an arms-length contract, but if we tried to sell the grain for less, intermediaries would snap it up and sell it at the (higher) market price. We would impoverish ourselves without helping the poor townsfolk.Through this Locke has something to say about Sandy, New Jersey, and price gouging. New Jersey has an anti-gouging law that prohibits retailers from raising prices more than 10% in the aftermath of a natural disaster. After Sandy struck, most gas stations didn’t have power and couldn’t pump, so there was a shortage. People waited hours to get gas. If the price had been allowed to clear, owners would have rented generators to get the other stations going—or they would have trucked in gas from Pennsylvania. The gas shortage wasn’t caused by Sandy, it was caused by a government price control that set the price too low—so there was too much demand and not enough supply. There’s no legislature that can repeal the law of supply and demand.Locke isn’t heartless. If a buyer is especially desperate, he says it’s unjust to charge more than the market price. But voluntary, informed, competitive markets produce efficient outcomes where everyone is better off. Locke understood this. It would be great if our lawmakers did as well.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @tengdin

Good BeginningsHow do you start your day? Checking email? Catching up on office gossip? A leading business magazine asked several successful entrepreneurs what they do when they first get to their desks.The most surprising answer has to do with email. Many of them put off checking their email until 10 am, or even later. It’s a way to take charge of the day. If you let email decide what you do and when you do it, you end up feeling pushed around and unfocussed. Instead, take the first few minutes to organize yourself and make sure you’re keeping first things first.Second, they try to tackle at least one hard task first thing in the morning. “Eat a live frog first thing in the morning,” Mark Twain once said, “and nothing worse will happen to you for the rest of the day.” Organize the task the day before, then tackle it first thing the next morning. You’re fresh, there aren’t a lot of distractions, and before long the job is done. Then wade into emails and other issues. But for the rest of the day, nothing else looks so bad, and you’ve done something difficult.The third thing is gratitude. Try to think of a dozen things you’re grateful for, in your job, your family, your marriage, and your personal life. A grateful spirit is winsome, and it’s contagious. It improves the way you interact with people.And that’s the last thing: these leaders keep themselves grounded in the human side of business. Whether through direct customer service, following up with contacts, or checking in with co-workers you don’t see very often, putting a human face on what you do during that first hour can remind you why you’re doing this.Starting strong; staying focused—good beginnings make for good days.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @tengdin

Storms Both Physical and Financial A winter storm is hitting the northeast less than two weeks after Hurricane Sandy crashed into the New Jersey. And it made me think of the new banking regulations. The early winter storm now afflicting the east coast seems especially cruel. People still waiting for power have to shovel snow and then go into their cold houses. And it will severely hinder efforts to recover from Sandy. Utility trucks can’t fix downed lines if they’re sliding into the ditch themselves. And while winter storms are common, hurricanes like Sandy don’t hit Jersey and New York that often. This was the first hurricane to slam directly into the Jersey shore in over 100 years. Life has gotten a lot more complex since then: our cities are larger, our amenities require more power, and everybody needs to charge their smart phones. Since life is so complex, our emergency response needs to be multi-layered and sophisticated, if we’re going to keep power, gas, healthcare, sanitation, and public transportation going. Simple ideas like evacuation and rescue won’t work if thought isn’t given to providing food, water, and public safety to those in the shelters. The same is true for banking in the face of a financial crisis or economic downturn. There’s been some criticism of the new bank regulations: they’re too complex; we should just go with a simple leverage ratio for all our banks to keep our finances safe, and reinstitute Glass-Steagall. But banking, like life, is a lot more complicated now than it was in the ‘30s. What worked 80 years ago won’t work today. For every complex problem there’s an answer that’s clean, simple, and wrong. The new bank rules need to reflect current financial reality. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @tengdin

Running in Place  - Now what?After all the politicking and polling and speechifying and caucusing, our national political scene returns to the status quo ante. President Obama is reelected, the House remains Republican, and the Senate remains Democratic. The President won the popular vote as well as the Electoral College count, and even if his election wasn’t the wave that it was in 2008, it was convincing.So what has changed? For one thing, it’s clear that President Obama now “owns” the economy. In 2009 he took office during an economic swoon brought about by the mortgage bubble and housing collapse. He inherited an economic mess, and most folks were willing to cut him some slack as he tried to find ways to improve the economy. But now any mess he inherits is his own. His current policies are likely to continue, even if some of the personnel change.Second, this election was decisive. There will be no endless series of lawsuits and appeals. So we can expect decisive action on the “fiscal cliff” that the economy is facing due to the debt-ceiling deal of 2011. Most economists believe that if we see the series of automatic spending cuts and tax hikes that this deal put in place, we will see a recession. No one wants that.Third, the Republican Party will need to do some soul-searching. In the race for the Senate, establishment candidates lost, tea-partiers lost, well-financed business-people lost. In a weak economy with six Democratic Senators retiring, the Republicans couldn’t pick up any seats. Was it demographics that defeated them? Stupid salesmanship? Or something deeper?Finally, for those of us who live in swing-states, our phones should stop ringing, at least for a few months. We can all be thankful for that.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @tengdin