Whitney Tilson’s Latest Newsletter

Whitney Tilson’s Latest Newsletter

Whitney Tilson's Latest NewsletterThe latest from Whitney Tilson:

My favorite authors are out with new missives.  First,  is Howard Marks with What’s Behind the Downturn  Here’s an excerpt:

I feel the prosperity we enjoyed in the final decades of the twentieth century was

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considerably better than “normal,” and better than we’re likely to see up ahead.

I’m not implying a world without growth or otherwise permanently negative. Just

one without the prosperity, dynamism or positive feelings of past decades.In

addition, the newness of the macro picture and some of the problems – and the opacity of

the solutions – certainly make it less clear in which direction we’ll go.


It’s my belief that things went better in the late twentieth century than we have reason to

expect in the years ahead. We could get lucky again, of course, but it would be

downright imprudent to make investments predicated on that assumption. Thus at

Oaktree we’re making allowance for things that may go less well than they did in

past periods. Cheapness provides a margin of safety today, but only so much.

We’re moving forward, but cautiously.


2) Here’s GMO’s Jeremy Grantham with Danger: Children at Play:


My worst fears about the potential loss of confidence in our leaders, institutions, “and capitalism itself” are being

realized. We have been digging this hole for a long time. We really must be serious in our attempts to resuscitate the

“average hour worked” and the fortunes of the average worker. Walking across the Boston Common this morning,

I came to realize that the unpalatable (to me) option of some debt forgiveness on mortgages looks increasingly to be

necessary as well as the tax changes I discuss here.


To go further, if we mean to prosper long term, I am sure we need to act to make debt less attractive to everybody: it

really is a snare and a delusion.


Stop Press

At the close on August 8, a slightly cheap equity portfolio could be put together comprised of U.S. high quality,

emerging markets, Japan, Italy, and European growth stocks. On our data, the imputed 7-year return of the package

today would be about 6.5% real!* Quality stocks, especially in the U.S. but almost everywhere, continue to

handsomely outperform. Regrettably, this means that they have declined very considerably less than the indices. In

its asset allocation accounts, GMO is modestly underweight equities, partly because of the desperately unattractive

yields on fixed income. We are now very modest buyers for the first time since mid 2009.


3) Re. my comments about Japan in my last email, attached is a more optimistic piece by GMO from April.  Excerpts:


Japan’s fiscal situation has little in common with Europe’s PIIGS. For a start, sovereign defaults tend to afflict

countries that depend on foreign capital. This was the case for Greece and other countries in the European periphery.

Japan, on the other hand, remains the world’s largest international creditor and the overwhelming bulk of its public

debt (roughly 94%) is domestically held. It is very rare for democratic countries to default on debt held by their own

nationals. Sovereign defaults may also be prompted by economic contraction in countries that are locked into an

uncompetitive exchange rate. But unlike the PIIGS, Japan has its own currency, controls the central bank, and can

devalue if necessary. Japan also runs a large current account surplus, whereas the PIIGS sport deficits. Banking crises

can induce sovereign debt crises, as Ireland and Iceland have recently shown. But after huge write-offs during the past

two decades, Japan’s leading banks have robust balance sheets.


The focus on the downward trend in household savings is highly misleading. Unlike Greece and, for that matter, both

the US and UK, Japan’s gross savings rate (at 23% of GDP) remains high. In fact, Japan’s fiscal deficit is the result

of too much saving. Since the bubble burst in 1990, Japanese companies have been paying down their debts and

raising cash. The financial surplus of the private sector has produced a shortfall in aggregate demand, which has been

plugged by government deficits.15 Once corporate deleveraging ends and the Japanese start spending more and saving

less, then (everything else being equal) the government deficit should automatically contract.


There are other reasons to be relatively sanguine about Japan’s sovereign credit. The headline debt figure at more than

twice GDP overstates the problem. This number includes debt held by various government entities and sterilization

bonds, but excludes the government’s large foreign exchange reserves. A more appropriate figure is the net debt,

which stands at 114% of GDP (see Exhibit 4). By this yardstick, the debt is only four times tax revenues.

One should also take into account the fact that government revenues are currently depressed (see Exhibit 5). After

two decades of deflation, the tax take is lower today than in 1990. Corporation tax receipts are around half their 1990

level. Economists often refer to the “inflation tax,” which occurs when the effective tax rate increases with inflation.

Japan’s public finances have suffered from the opposite effect – a “deflation tax rebate.” The Japanese are not heavily

taxed by modern standards. Government revenues are approximately 30% of GDP, compared to an average of around

40% in Western Europe. Consumption tax in Japan is much lower than in the West. The greatest beneficiaries of the

deflation rebate have been the elderly who, directly or indirectly, own most of the government debt but aren’t paying

their share of the fiscal burden.


Nor is it true that Japan’s public finances must necessarily collapse if interest rates were to rise. This would only be

the case if rates rose while tax revenues remain unchanged. In fact, Japan’s tax revenues have shown themselves to

be sensitive to changes in nominal GDP. If rates rise because deflation has ended and economic growth is picking up,

then revenues may well rise faster than any increase in debt service. Under these circumstances, the government’s

ratio of debt to GDP would rise initially but start falling after a few years. Interest payments on the outstanding debt

would never become unmanageable.


And here’s the conclusion:


In the 1980s, “Japan is different” was a proud boast. The last two decades have shown Japanese differences in a less

flattering light. But some of its achievements have been glossed over. Japan still compares favorably to the US on

many measures: its energy efficiency is far greater; the population enjoys greater longevity while spending far less on

healthcare; income inequality is much less pronounced; since 2000, Japanese GDP per capita has even outpaced the

US. Japan’s car industry still leads the world and, as recent events have shown, Japanese components manufacturers

continue to occupy many vital niches in the global supply chain.


Nevertheless, Japan has been slow to adapt to changing realities; whether to the collapse of the bubble economy,

the decline in its population, or the rise of its Asian neighbors. Far from conforming to Schumpeterian notions

of economic development, Japan has followed its own unique path of “creative self-destruction.” If the country

continues on its recent path, the doomsters’ dire predictions will eventually come to pass. Tokyo needs to get its fiscal

house in order. The country needs to improve its trend growth rate. Deflation must be dispelled. Japanese companies

must generate better returns.


These are not impossible demands. The fiscal situation can be rectified. Taxes can be raised on consumption and on

the elderly. Tax revenues will rise once deflation ends and the economy starts growing again. With sufficient political

pressure, the Bank of Japan might be persuaded to achieve its inflation target. This should bring down real interest

rates. If properly incentivized, corporate managers might find the will to raise profit margins. They might even find

a way to consolidate the over-supplied domestic market. Numerous supply-side reforms could improve productivity.

The workforce might be expanded with greater female participation, or foreign immigration (heaven forbid!).


4) Below is Bill Gross’s latest Investment Outlook:


* Liquidity concerns may affect all European peripheral bond markets unless the European Central Bank counters the rush for the exits with an enlarged daily checkbook.

* In the U.S., discord between rich and poor has led to lower, not higher, Treasury yields as approaching recessionary winds force the Fed and private investors to favor bonds.

* We prefer investing in the “cleaner” dirty shirt countries of Canada, Australia, Mexico and Brazil, along with non-dollar currencies that have strong trade ties with the Asian continent.


5) Below is Dan Loeb’s letter to Yahoo:


Third Point LLC (“Third Point”) is a registered investment adviser with approximately $8 billion under management.  We are writing to inform you that certain investment funds we manage have acquired a 5.1% interest in Yahoo! Inc. (the “Company” or “Yahoo”), bringing our holdings of common stock and currently-exercisable equity options to 65,000,000 of the outstanding shares, and positioning us as the Company’s third largest outside shareholder.


This letter details our principled demands for sweeping changes in both the Board of Directors (the “Board”) and Company leadership, and outlines the hidden value of Yahoo, which has been severely damaged – but not irreparably – by poor management and governance.


6) The guys at M3 are the smartest bank analysts I’m aware of.  Their latest letter, shared with permission, in which they show that banks are engaged in extend-and-pretend and are juicing earnings by reducing allowances for loan losses:


On August 23, the FDIC released its second quarter 2011 Quarterly Banking Profile, a statistical piece

summarizing the state of the banking industry. The most recent edition of the Profile reveals that the

banking industry continues to support earnings by releasing loan loss reserves, despite only slight

improvement in credit quality. Additionally, the abundance of balance sheet liquidity present in the

industry suggests that banks will have a difficult time generating loan growth while still adhering to

sound underwriting principles.


The banking industry earned $28.8 billion in the second quarter, representing a 9.8% return on

tangible equity. Earnings improved 38% over the same period a year ago, but declined 1% compared

to last quarter. Industry wide loan loss provisions totaled only $19 billion in the second quarter,

representing the eighth consecutive quarterly decline and the lowest provision expense in four years.

Further, for the fifth consecutive quarter, net charge-offs outpaced provision expense, and

consequently, the coverage ratio (loan loss reserves divided by nonperforming assets) fell to a cyclical

low 42%.


While credit costs continue to decline, delinquency trends have not followed the same downward

trajectory. Nonaccrual assets appear to be dropping significantly (down 18% from the peak in 2010),

but this is largely the result of banks restructuring problem loans. We believe banks are restructuring

underwater loans with the hope of keeping borrowers attached long enough for collateral values to

recover. As the chart below illustrates, troubled debt restructurings (TDRs) have increased 84% since

nonaccrual loans peaked, and today, there is an additional $1 of restructured loans for every $3 in

nonaccrual assets.


7) An article about how Warren Buffett, Bruce Berkowitz and Francis Chou are investing in US financials (as are we – and, like Chou, we like the TARP warrants, and own those of JPM and WFC):

A pretty simple investing formula thus becomes: buy the banks that have survived immediately after a blow-up, when everyone hates them. Hold them for a few years until earnings and balance sheets recover. Then sell them when most investors are no longer afraid of the sector.

That formula seems to be exactly what Bruce Berkowitz of the Fairholme Funds and Warren Buffett are ascribing to. Both Berkowitz and Buffett bought into the banking sector in a large way in the early ’90s after the last major banking collapse. Specifically, both made large investments in Wells Fargo (WFC) when the general consensus was that the California real estate collapse was going to destroy the company.

Now both investors are doing so again, with their headline investment being Bank of America (BAC). They buy when the banking sector is still covered with the wretched smell of the last disaster. They will sell when headlines improve and other investors lose their fear.

Another well-respected and risk-averse Canadian value investor named Francis Chou has also invested heavily in the American banking sector in the past year. Chou however has decided to try and amplify his returns by not simply investing in shares of Bank of America and other banks directly, but rather by investing in the warrants of these companies that were issued to the US Treasury during the TARP program.

8) Amidst all the bearishness on Europe is this promising development:

As leaders in Europe try to contain a deepening financial crisis, they are also increasingly talking about making fundamental changes to the way their 17-nation economic union works.

The idea is to create a central financial authority — with powers in areas like taxation, bond issuance and budget approval — that could eventually turn the euro zone into something resembling a United States of Europe.

Officials have been hesitant to publicly endorse such a drastic change. But privately they say the issue has gained urgency in recent months, as it has become clear that Europe’s current approach, which requires unanimity on any significant moves, is unwieldy and inefficient. The idea is being promoted by some global financial officials, who worry about the risks that continued uncertainty in Europe poses to the global economy.

Full article here.

9) Jonathan Weil on the Sino-Forest debacle:

The credit rater Standard & Poor’s may have been late to throw Sino-Forest Corp. (TRE) into the wood chipper when it withdrew its opinion on the company’s debt this week. At least it wasn’t last.

The end seems near for Sino-Forest. The Chinese-Canadian timber company’s bonds are priced for a default. Securities regulators in Canada have accused the company of fraud and suspended trading in its stock. One question lingers: Which of the company’s paid opinion merchants will be the last to step aside? Will it be a credit rater? Or will it be the company’s auditor, Ernst & Young LLP in Toronto, which has yet to rescind any of its reports on Sino-Forest’s finances?

So far Ernst looks like the favorite, with only one rating company left in the hunt. Think of it as a contest between giant tortoises to see which one is slower. This time-honored ritual — of market gatekeepers waiting to blow the whistle until long after a scam has been exposed — has become so familiar, we might as well revel in the spectacle.

Fitch Ratings withdrew its junk rating on Sino-Forest on July 14, six weeks after the short-selling research firm Muddy Waters LLC released a lengthy report accusing the company of fraudulently overstating its timber holdings in China. S&P pulled its rating this week after downgrading the company to CCC-, three levels above default, citing “heightened information risks.” That’s a euphemism for “we have no idea what’s going on here.”

Left Behind

This leaves just Moody’s Investors Service and Ernst, both of which, like S&P and Fitch, are paid by the same companies on which they render opinions. Moody’s this week downgraded the company three steps to Caa1, its fifth-lowest mark. That’s well into junk territory. So at least Moody’s is on record saying that Sino-Forest is a very high credit risk.

Ernst is still clinging to its position that Sino-Forest’s books are clean, under the accounting profession’s usual pass- fail standard. Beyond that, the firm refuses to speak publicly about its audit work for the company, whose board includes two former Ernst partners.

There’s every reason to believe Muddy Waters’ call was spectacularly correct. Once again a Big Four accounting firm seems to have been caught with its pants down, having told the investing public for years that a multibillion-dollar enterprise’s numbers could be trusted, only to see its imprimatur discarded by the markets and its conclusions upended by government investigators. Even the lowly credit raters, notorious for being slow to pull the trigger on dying companies, have been quicker on the draw this go-around.

10) It’s very interesting (and unusual) to see how vocal Buffett has gotten on this.  He must really believe that our government is being hijacked by the Tea Party:

Warren Buffett, the self-made billionaire and son of a former Republican congressman, has widened the rift with his father’s party by pressing for tax increases on the wealthy and reinforcing ties with President Barack Obama.

Buffett endured scorn from Republicans this month after he called the Tea Party approach to budget talks “insane” and proposed raising $500 billion by taxing the richest Americans. Buffett, chief executive officer of Berkshire Hathaway Inc., was cited as an exemplar by Obama at least three times since July.

“Whenever Buffett says something, you can almost put money on the fact that within the next 48 hours, Obama’s going to use the phrase, ‘My good friend Warren Buffett says blah, blah, blah,'” said David Rolfe, chief investment officer of Berkshire shareholder Wedgewood Partners Inc. “If you’re going to tread into those waters, you need to expect the brickbats.”

Buffett’s criticism contrasts with praise he offered in the last decade to former California Governor Arnold Schwarzenegger and the political appointees of former President George W. Bush. The Tea Party movement, which made gains in last year’s elections, was faulted by Buffett for silencing other Republican voices. Buffett plans to hold a Sept. 30 fundraiser in New York City for Obama’s re-election bid, Democratic officials said.

“He crossed the line from being an observer to being more of a participant,” said Jeff Matthews, author of “Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett.” That, “to a lot of people seemed kind of weird and prompted a hostile reaction.”

Full article here.

11) Hilarious!
Yes, It’s True: Ben & Jerry’s Introduces ‘Schweddy Balls’ Ice Cream Flavor
September 7, 2011

by Eyder Peralta

We thought it would never happen. When we reported that comedian Ana Gasteyer had spilled the beans on a new Ben & Jerry’s ice cream flavor based on aSaturday Night Live skit that pokes fun at NPR, we thought it would never happen.

Ben & Jerry’s Schweddy Balls ice cream.

But we were wrong. Ben & Jerry’s announced today that “Schweddy Balls” ice cream is on its way to store shelves across the country.

As we explained in June, “in case you don’t get the reference, the skit is a hilarious commentary on NPR’s, um, uniquely soothing sound. [Alec] Baldwin plays Pete Schweddy, a guest on a fake NPR show called Delicious Dish. Pete makes holiday treats like cheese balls, popcorn balls, rum balls and his famous Schweddy balls. The skit is an exercise in double entendres.”

We talked to Ben & Jerry’s spokesman Sean Greenwood and asked him, “What are you guys thinking?” We were imagining someone who’s never seen the skit walking the grocery aisles and stumbling on the flavor.

Greenwood laughed.

“We’ve always been a company that has had a sense of humor,” he said. Sometimes, he said, they spend time discussing serious business and other times “we just do fun.”

“This is just plain silly,” he said. And it tastes pretty good, he promised.

The flavor is made up of “vanilla ice cream with a hint of rum and is loaded with fudge covered rum balls and milk chocolate malt balls.”

It’ll be available for a limited time in about 30 percent of stores that carry Ben & Jerry’s ice cream.

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