>The world’s greatest stock picker? Bet you sold Apple and Google a long time ago. - JOHN MAULDIN

My good friend Barry Ritholtz, famous for launching The Big Picture blog (and since graduating to being a regular Bloomberg columnist as well as writing a weekly column for the Washington Post), is well-known for being a contrarian. Barry is a regular dinner partner when I get to New York, and he also participates in the annual Maine fishing trip. We frequently trade information … and barbs. The word colorful affectionately comes to mind when I think of Barry (and maybe opinionated would work).

I can usually count on him to find at least a few things to disagree with me on at our dinners. No matter what devastating arguments I produce to demonstrate the errors in his thinking, he conjures up new facts to support his flawed positions. We have had a few of these episodes as members of a panel in front of a large public audience, much to the amusement of the spectators (and watching Barry can be an entertaining spectacle). My only real frustration with Barry is that he is mentally faster than I am and he seemingly remembers every obscure data point from the last thousand years. I consider it a triumph if I merely hold my ground.

But one thing we do agree on and are both passionate about is that we human beings were not designed for these modern times. As I so often say, we evolved on the African savanna dodging lions and chasing antelopes. We have converted those survival instincts into an unwieldy approach to dealing with financial markets, which is not the optimal way to approach investing. Both of us write a great deal about behavioral investing and the foibles of human nature.

I was struck by the insights of Barry’s latest Washington Post column. How difficult it is for us humans to hold on in the middle of dramatic volatility. Don’t you wish you had held Apple for the last 10 years? A 1000-bagger is not to be sneezed at. But dear gods, the volatility! And what about the stocks that once looked like a better bet than Apple that went to zero? How do you decide when to hold and when to fold? (Cue Kenny Rogers.)

This is a short Outside the Box, but it’s one that should make you think, which is the purpose of this letter.

And in a departure from my usual close, I want to offer two links. The first is to a fascinating web post at something called distractify.com of 52 colorized historical photos. You have seen most of these photos in black and white (or at least you have if you have reached my advanced age). Seeing them in color is quite another story.

Second, and not for the faint of heart, is a link to a rather heated exchange between Ben Affleck and Bill Maher over radical Islam and Islamaphobia. I generally find Maher annoying, sometimes in the extreme. But this “conversation” is instructive. It illustrates the tensions in the Western world around dealing with Islamic beliefs and the religion in general. The other guests chime in with fascinating anecdotes. You can decide for yourself who wins this argument, but it is one that is increasingly important in our world. And I am not sure anyone will be comfortable with the answers. This is courtesy of my friends over at Real Clear Politics.

I am still luxuriating in the aftermath of my birthday party on Saturday night. Friends flew in from all
over the country (and from around the world) and surprised me. Too many to mention, but I was deeply honored and humbled. My staff and friends and family put the whole thing together (huge thanks to Shannon and Mary and Shane and my kids). My daughter Melissa put together a playlist on Spotify of all the songs she has heard me listening to over the years. Three and a half hours of one hit after another. We are working on making it available to those of you who are already on Spotify.

And just for the record, that morning I did 66 consecutive push-ups on my 65th birthday. I then went on to do a total of 360 push-ups (50×5+44) in less than two hours, with the help of an Avacor machine to cool me down between sets, in a workout that included a similar number of abs, lat pulldowns, arm exercises, etc. Knock on wood, I do not plan to go gently into that good night. As a geek, I am coming late in life to loving the gym. But better late…

It is time to hit the send button. I am off to the Great Investors’ Best Ideas Symposium here in Dallas.

It is a who’s who of famous investors, all of whom agreed to speak and to give one investment tip to aid a great charity. Bill Ackman, David Einhorn, Paul Isaac, Bill Miller, Ray Nixon, Richard Perry, T. Boone Pickens, Michael Price, Tom Russo, and moderated by Gretchen Morgenson. Have a great week while thinking about how to get your human nature under control.


Your more human that I want to admit analyst,

JOHN MAULDIN

Source: www.mauldineconomics.com


RISH TRADER

>The Seven Great Myths of an Indian Collapse

Myth #1 – The credit bubble


Myth #2 – The investment collapse


Myth #3 – Disappearing growth


Myth #4 – Out-of-control inflation


Myth #5 – A cost of capital crunch


Myth #6 – The mountain of dollar borrowing


Myth #7 – The end of the rupee


To read report in detail: INDIAN COLLAPSE
RISH TRADER

>CAPTURING DOMESTIC DEMAND IN EMERGING MARKETS: Neither Small Caps Nor Multinationals Are a Good Proxy

We believe one of the most compelling investment opportunities over the next few years is likely to be in companies that serve domestic demand within emerging markets. Our case rests on two underlying and interconnected forces – one economic and the other demographic. As poor countries get richer, they save as much as they can. Savings rates usually rise until countries reach a range of $3,000 to $10,000 per capita GDP. Once in that range, savings rates begin to decline and consumption becomes a larger part of GDP growth as society starts to provide a social safety net. At this level of wealth, per capita consumption of all goods and services rises in a highly non-linear fashion. For example, while Chinese per capita
GDP quadrupled from $1,000 to $4,000 during the past decade, auto sales rose from one million vehicles per year to over 17 million. Markets rarely anticipate this kind of non-linear growth.


Fifty percent of all emerging markets (by market capitalization) are now in this sweet spot of shifting from savings to consumption.


Further strengthening the economic case is a shift in demographics: a record number of people are coming into their earning years in emerging markets at the same time that baby boomers are starting to retire in the developed world. As a result, we believe that the world is in the midst of a massive shift in demand from the developed world to emerging markets.


As this domestic demand play gains momentum, we hear increasingly that the best way to capture this theme is to buy small cap emerging stocks. We believe, however, that this is a mistake and that focusing on companies that specifi cally serve domestic demand is a more effective way to exploit the opportunity. Besides, why buy a proxy when you can buy the real thing?


First, let’s look at the core of this argument. Favoring small cap stocks rests on the presumption that large cap emerging market stocks represent export and globally-oriented businesses. As a result, removing these large cap names from the investable universe would leave a collection of companies that are focused primarily on domestic demand. The fi rst part of this contention is true, the second is not. Large caps are geared highly to global demand. However, the small cap universe alone does not represent a pure play on domestic demand and, in fact, is as exposed to globally-sensitive sectors as the large cap universe.


If one divides all emerging market companies into those that are domestically-oriented (Financials, Consumer Discretionary, Consumer Staples, Health Care, Telecoms, and Utilities) and those that are globally-sensitive (Energy, Materials, Technology, and most Industrials), globally-sensitive sectors are almost as highly represented in aggregate in the small cap universe as they are in the broad emerging markets universe.


The sector weights of the Emerging Broad and Emerging Small Cap universes are shown in Exhibit 1. In fact, globally sensitive sectors represent 45% of the small cap universe vs. 47% for the broad universe as of September, 2011.


If one were to construct a universe of domestic companies (handpicked on a company-by-company basis based on who their ultimate customers are rather than market capitalization), one would see that it is nothing like the small cap universe. Exhibit 2 shows sector weights of this true domestic demand universe alongside those of the small cap universe. We
can see that the domestic demand universe has a far lower exposure to globally-sensitive sectors than does the small cap universe. In fact, even the companies represented within globally-sensitive sectors of the domestic demand universe are those that specifi cally serve domestic demand (e.g., technology companies whose business is primarily within emerging
markets) rather than those that export to developed countries. An example of such a company is Kingdee International, which provides Chinese language ERP software and services and competes with the likes of SAP for small- and medium size businesses in China.

One might raise an eyebrow when noting that fi nancials are such a large part of this domestic demand universe. This concern, however, is somewhat misplaced. Most emerging market fi nancials are an extremely good play on demand growth because they provide the credit that is essential to the rapid growth of these economies. Second, most emerging market financials sectors are underleveraged and have extremely strong balance sheets. The average Tier 1 capital ratio for banks in emerging markets is north of 15% versus 8-10% for developed banks. The one exception is Chinese fi nancials: there are serious concerns about their health in any housing/ infrastructure downturn. Any actively managed strategy would most likely take this into account.


One other problem with using small caps as a proxy for domestic demand is that they tend to have low profi tability and higher volatility of earnings, given the high proportion of materials and industrial companies. Exhibit 3 shows the average return on equity (smoothed over 36 months) for small caps and the domestic demand universe. Clearly, small caps have been less profi table historically than true domestic demand companies.


Last, but not least, not all domestic demand is served by companies domiciled within emerging markets. Global multinationals also serve this rising demand and, in some cases, are dominant players. A complete domestic demand universe should include multinationals that receive a substantial part of their earnings/revenues from emerging markets or will within a few years.


While very few multinationals currently meet this test of being driven largely by emerging demand, they will inevitably become a larger part of this theme. While some commentators make the argument that investing in multinationals alone is the best way to access domestic demand in emerging markets, we believe that domicile is irrelevant. What matters is whom they serve. 

The winning companies could be domiciled in either developed or emerging markets. The primary advantage that domestic companies have over multinationals is home fi eld advantage in the form of having well-established local brands, supply chains, products adapted to local conditions, and barriers to entry in the form of government xenophobia and anti-competitive rules. The biggest advantages that multinationals have over domestic companies are global brands, management expertise, and access to cheaper capital and supply chains. In the early stages of penetration to a market, the locals have economies of scale in their favor, which switches to an advantage for multinationals as their market share grows and they are able to source globally.


To conclude, the best way to access demand from the burgeoning middle class in the emerging markets is to invest in companies globally that directly serve that demand, rather than using emerging market small caps or global multinationals as a proxy.


In short, if you want to buy domestic demand, buy the real thing, not a poor proxy.


RISH TRADER

>WHY WARREN BUFFET IS BULLISH ON AMERICA

To read full article: WARREN BUFFET

>How the Great Recession Was Brought to an End

The U.S. government’s response to the financial crisis and ensuing Great Recession included some of the most aggressive fiscal and monetary policies in history. The response was multifaceted and bipartisan, involving the Federal Reserve, Congress, and two administrations. Yet almost every one of these policy initiatives remain controversial to this day, with critics calling them misguided, ineffective or both. The debate over these policies is crucial because, with the economy still weak, more government support may be needed, as seen recently in both the extension of unemployment benefits and the Fed’s consideration of further easing.

In this paper, we use the Moody’s Analytics model of the U.S. economy—adjusted to accommodate some recent financial-market policies—to simulate the macroeconomic effects of the government’s total policy response. We find that its effects on real GDP, jobs, and inflation are huge, and probably averted what could have been called Great Depression 2.0. For example, we estimate that, without the government’s response, GDP in 2010 would be about 11.5% lower, payroll employment would be less by some 8½ million jobs, and the nation would now be experiencing deflation.

When we divide these effects into two components—one attributable to the fiscal stimulus and the other attributable to financial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative easing— we estimate that the latter was substantially more powerful than the former. Nonetheless, the effects of the fiscal stimulus alone appear very substantial, raising 2010 real GDP by about 3.4%, holding the unemployment rate about 1½ percentage points lower, and adding almost 2.7 million jobs to U.S. payrolls. These estimates of the fiscal impact are broadly consistent with those made by the CBO and the Obama administration. To our knowledge, however, our comprehensive estimates of the effects of the financial-market policies are the first of their kind.3 We welcome other efforts to estimate these effects.

To read the full report: END OF GREAT RECESSION

>Is Austerity the Road to Ruin? - JAMES MONTIER

Let me share with you one of my guilty secrets: I occasionally indulge in the dark art of macroeconomics. I don’t try to forecast the future (that would be truly pointless), but I do think that understanding the macro backdrop can, on occasion, help inform the investment process. For instance, those who understood the impact of a bursting credit bubble stayed well clear
of the value trap opportunities offered in financial stocks during 2008. Those who focused purely on the bottom-up tended to plow in and repent at leisure, as the deteriorating fundamentals generated a permanent loss of capital. So why share this confession now? I think we are seeing
a very worrying trend around the world: the rise of the Austerians. This breed is the latest incarnation of what used to be called the deficit hawks, a group set upon reducing what it sees as the government’s profligate spending.

The power of the paradox of thrift
The Austerians either ignore or dismiss the paradox of thrift. This paradox (which appears first in the Fable of the Bees1) was popularized by John Maynard Keynes inThe General Theory of Employment, Interest and Money. He wrote:

For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.

In essence, the paradox of thrift is a fallacy of composition. Whilst it may be perfectly rational for one household (or section of the economy) to save more, if everyone tries to save more, total income is lowered. If you aren’t spending, then neither are the people who depend upon
you for their source of income. Firms won’t invest if there is no demand for their products, and we end up in a nasty downward spiral.

To read the full report: Is Austerity the Road to Ruin?