Notes To James Grant’s Spring Conference 2007 by Redfield, Blonsky & Co.
Very often I write these notes as a future reminder to me for what I found interesting, or perhaps items I would like to save for future reference. These notes could be error filled, and I apologize for any inadvertent errors.
I. Grant’s Spring Investment Conference April 24, 2007
I have been a subscriber to Grant’s Interest Rate Observer since around year 2000. I find James Grant’s work to be thought provoking, honest and often hilarious. I enjoy his sense of humor as much as I enjoy his financial Insight. I was thrilled to have him autograph my book of his on the financial life of Bernard Baruch. Here is a link to his website http://www.grantspub.com/conference/
A. The first speaker was David A. Rosenberg, Chief North American Economist from Merrill Lynch. I have read his works for years, and really enjoy his writings and thought process. His presentation was titled, “Soft Now, Hard Later.” His first words were, “I just wanted to get things out of the way. I did not steal this title from our Pfizer analyst.” I enjoyed how James Grant introduced David, “David is from Canada, hence he must be a nice guy.” He wouldn’t comment on the mark to market of commercial paper and potential aggressiveness, as he cited his compliance department present, and didnt feel comfortable answering. His body language, to me, expressed an affirmative to the question.
1. I have a note to myself to monitor the following ratio, which David thought was quite important. “GDP Growth / Population Growth.” That is a natural ratio, and material long term deviations from such, could prove interesting. I think David mentioned that future population growth in USA is expected to be 1.0%. I am not certain of that, and I do not know what the past population growth was.
2. Claims that “Inventory / Sales ratio is at a 4 year high. The remainder of this paragraph are my thoughts and not mentioned by David. I have been a fan of this ratio for a long time. Here is what I wrote in regards to Peter Lynch mentioning the ratio http://www.rbcpa.com/Understandablestocks.html . “Inventories: Are inventories piling up? This is a particularly important figure for cyclicals. Lynch notes that, for manufacturers or retailers, an inventory buildup is a bad sign, and a red flag is waving when inventories grow faster than sales. On the other hand, if a company is depressed, the first evidence of a turnaround is when inventories start to be depleted.” The importance of this ratio is that when goods are produced, a company expects to sell their inventory. As inventory grows, earnings will grow as well, via Cost of Sales being reduced by ending inventory. If that inventory does not follow with a sale, then future profits will fall or cause potential stress. This stress could be lower profits, inventory impairments and cash flow concerns. Hence, one of my favorite indicators.
3. David claims that USA mortgage and home equity withdrawal, has a lag of 4 – 6 quarters on the consumer. He said to watch employment, as it follows capital spending with a lag. I had a question mark next to my notes, and just didn’t follow the theory, or I wrote it down wrong.
4. He showed 2 graphs. David claims that the “Index of Leading Economic Indicators,” is the most important indicator. He said the reason it is his favorite, is because “it works really well, watch this forever.” He claims that the current reading of “The index of Coincident Economic Indicators” is a lagging indicator and shouldn’t be focused on. He claims that the Coincident indicator has always shown the economy being okay, even when the economy was going into a recession. He cited the years of 1990/1991 and 2001 in contrast to the leading indicator for the same years. As of March 2007, the coincident indicator is at a level of 2, whereas the leading indicator is at a level of 0, and has been dropping since 2004.
5. He claims, “When the fed tightens….bad things tend to happen.” He cited various incidences since 1972 and how the stock market lagged after these incidences. Examples were bank failures in 1974 and 1981, and New Century Financial in 2007.
6. He cited the mortgage delinquency rates of Prime mortgages to be at a 3 year high and Sub-prime a 5 year high. He insinuated that if you had a pulse you would qualify for a mortgage.
7. The next set of graphs he presented was very interesting. He claims that employment growth at collection agencies are at a 4 year high, and growth at credit bureaus an 11 year high. He calls this “counter cyclical charts.” It makes sense, if things were so dandy, why would collection agencies be having strong employment levels?
8. Claims that residential mortgage credit was a huge stimulus to GDP. From 1980 through 2000, the average ratio of “5 year change in residential mortgage liabilities relative to nominal GDP” has been on average a touch less than 0.6. The current average is 1.6. He feels that this has added 1% to GDP growth.
9. He feels that “housing inventory situation is rapidly deteriorating.” He feels that sub-prime situation will aggravate 14% or more of all mortgages.
10. He cited Alan Greenspan’s mention of “froth” in the housing market form July 20, 2005. I looked it up and found it here http://www.federalreserve.gov/BOARDDOCS/HH/2005/july/testimony.htm
“….Whether home prices on average for the nation as a whole are overvalued relative to underlying determinants is difficult to ascertain, but there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels. Among other indicators, the significant rise in purchases of homes for investment since 2001 seems to have charged some regional markets with speculative fervor.”
“The apparent froth in housing markets appears to have interacted with evolving practices in mortgage markets. The increase in the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages are developments of particular concern. To be sure, these financing vehicles have their appropriate uses. But some households may be employing these instruments to purchase homes that would otherwise be unaffordable, and consequently their use could be adding to pressures in the housing market.”
He discussed that Greenspan didn’t label the housing market as a bubble, but used the word frothy. He mentioned, and I looked up froth in www.dictionary.com Here is what they cite the definition as, “an aggregation of bubbles,..” David laughed as he said something like, “Greenspan didn’t see a housing bubble, he saw a series of bubbles.”
If you are further interested in reading about potential housing bubbles, you could look at some of the following links.
a. http://www.realtytrac.com/ – monitor foreclosures
b. http://rbcpa.com/housing.html – a page I haven’t updated in a long time
c. http://rbcpa.com/richardrussellonhomeprices020904.html – an interesting article on the 10% rule.
11. He claims the “US Debt-to-Income Ratio Rose as much in the past 5 years as it did in the previous 39 years”. In 1962 the ratio of “Household Debt / Income” was 63%, it stayed under 100% until 2001, and now stands at 137%. His argument is, that it sure appears that increased debt has led the consumer spending surge of the last 20 years. As I thought more about this, I related it to my own situation. I bought my house in 1991 for under $230K, well if I was to buy the same house today, at a good price, it would be somewhere between $650K and $900K. Hence, my household debt / income levels would increase dramatically. Nevertheless, something to ponder.
12. He claims that mortgage standards are the tightest in 16 years (1991).
He ran out of time to talk, as he was allotted an entire half hour ;-), but here are some notes of the handout.
13. Claims we are barely halfway through the housing recession.
14. “Housing completion always converge upon housing starts…..nine-months later.”
B. The second speaker was introduced as a nice guy as well, “as he is from Canada.” Bruce Flatt from Brookfield Asset Management (BAM)(57.06).
I really don’t have much to say on this. I have seen him speak once before, and just wasn’t swayed to investing in his company. Granted the last time I saw his presentation was at some point in the Spring of 2005, and the price has risen almost 200% since then. BAM is loved by many a value investor. Last year, Adam Weiss from Scout Capital spoke at Grant’s conference. Scout Capital has a large position in BAM. They apparently love the company. I really have nothing to add on BAM (sorry).
C. The third speaker was introduced. James Grant said something like this, “
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