They Can’t Help You

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They Can’t Help You

Before I start this evening, I want to add one follow-up to last night’s piece on Berkshire Hathaway. My summary was that it wasn’t a great year, and the profit margins are likely to shrink in insurance, because BRK is being conservative there. So why do I still own it for my clients and me?

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BRK is trading maybe 8% over the level at which it would begin buying back stock. Even in a pessimistic year, I expect BRK’s book value to rise to the level that triggers the buyback. Thus, I think the floor for the stock is pretty close below me, and there is a decent possibility that Buffett could do some things with the cash that are even better than buybacks, especially if the market falls into bear territory.

It is positioned well for most market environments, even one where insurance gets hit hard. BRK is “the last man standing” in any insurance crisis — they have the ability to prosper when other companies will have their capital impaired, and can’t write as much business as they want.

That’s why I own it.

Long BRK/B for my clients and me

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Onto tonight’s topic. This is partially spurred by an article at Bloomberg.com entitled Angry Americans: How the 2008 Crash Fueled a Political Rebellion. There was one graph that crystallized the article. Here it is:

Incomes have not improved for the bottom 80% of Americans over the last decade. Before I go on, recognize that the income distribution is not static. The same people are not in each decile today, as were in 2006. Examples:

  • Highly skilled students in a field that is in demand graduate and get jobs that pay well.
  • Highly skilled immigrants in a field that is in demand come to the US and get jobs that pay well.
  • Less skilled people who relied on the private debt culture to keep getting larger no longer have jobs that pay well in finance, construction, real estate, etc.
  • Workers and businessman who expected the commodities and crude oil boom to go on forever have seen their prospects diminish.
  • Some people have retired and their income has fallen as a result.
  • Layoffs have come in some industries because many people did not realize that they were lower skilled workers, and as such the work that they did could be automated or transferred to other countries.
  • Manufacturing continues to get more efficient, and we need fewer jobs in manufacturing to produce the same output (or more). This is true globally; manufacturing jobs are being reduced globally.
  • Technology firms that apply the advantages of the internet gain value, while legacy firms lose value. Whole classes of goods go away because they are replaced, and in other cases, some firms find that they can’t price their products to make a decent profit, while other firms can.
  • Some effects are demographic, like mothers ceasing work to raise children, or industries with a lot of older workers becoming uncompetitive because their pension plans are too expensive to fund.
  • Divorce usually ruins the prospects of the wife, if not the husband.
  • Throw in death, disability, substance abuse, and serious diseases.
  • And more…

Thus there is a lot of reason to look at the graph and not say, “The rich are getting richer,” but, “Those who are getting rich today are doing so faster than those who were getting rich back in 2006.”

My life is even an example of that… I make less than 30% of what I was making in 2006. On an income basis, I’ve gone from the top of the graph to the middle. I’m not upset, because I’m debt free, and manage my finances well. I’m grateful to have my own little firm, and every client that I have.

Resentment

That said, many feel that the comfortable life that was theirs has been denied to them by forces beyond their control. They think that shadowy elites want to turn previously well-off people into modern serfs.

It’s a tempting thought, because most of us don’t like to blame ourselves. Myself included, we all make mistakes. Here is a sampling:

  • Did we make a bad decision in the industry in which we chose to work? The particular firm?
  • Did we choose a bad field of study in college? Rack up too much student loan debt?
  • Did we borrow too much money at the wrong time? (Remember, debt is always a risk. If you don’t know that, you shouldn’t borrow money.)
  • Did you make bad decisions regarding your assets, and get too greedy or fearful at the wrong times?
  • Did you spend too much during your good years, and not save enough for the future?
  • Did you not buy the insurance that would have protected you from the disaster that hit you?
  • Throw in relationship errors, etc.

The truth is, changes in technology, and to a lesser extent demography, affect the entities that we work in, and affect our personal economics as a result. There are some politicians blaming immigrants for our problems, and that’s not a major source of our difficulties. Most people don’t want to do the work that unskilled immigrants do, and skilled immigrants get hired when there aren’t enough people seeking those positions.

There is a need for retraining, but even that has its difficulties, as technology is changing rapidly enough that more areas may face job reductions. Again, this is a global thing. Those that think that making trade less free will help matters are wrong. It’s not trade; it’s technology.

Some think that matters can be fixed by changing government taxes and spending. That would only help limitedly, if at all. Businesses and people can move to other countries. In an era of the internet, many more things can move than ever did previously.

Now, if the developed countries collaborated to unify tax policies, some of that would end. But cheating under such a regime is too tempting, just as Indiana and Wisconsin try to attract businesses to move out of Illinois. The relatively healthy governmental entities have advantages that allow them to prosper at the expense of the sick ones.

You’re Going to be Disappointed

Politicians live to promise. I can tell you right now that not one of the surviving candidates for President has a realistic proposal that could be voted up by the next Congress or the buyers in the US Treasury market. It’s all airy-fairy… just as most politicians have been since we stopped running balanced budgets.

I would encourage you therefore to look at your own situation and resources soberly, and assume that the next government will do nothing better for you than the current one. All of the main drivers of what could improve matters for the middle class are outside the power of any individual government, so plan your own situation accordingly and adjust your economic expectations down. After all, there is no place in the world that can promise its people prosperity. Why should the USA be any different in this matter?

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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