Archive for August, 2007

Home Prices Tumble 3.2%

Kurt Brouwer August 28th, 2007

Home prices are falling these days and have been for a year or so. This type of decline is the first we have seen in many years. Update: In general, the coastal regions of the country have had the most bubbly real estate markets (see here and here for more).

Kelly Evans of the Wall Street Journal reports [emphasis added]:

‘The decline in U.S. home prices accelerated in the second quarter as a glut of unsold homes and tighter lending standards continued to weigh on the market.

Home prices nationwide tumbled an average 3.2% from a year earlier, according to an index compiled by Standard & Poor’s Corp. The decline was sharper than the year-to-year decline in the first quarter, when the S&P/Case-Shiller national home-price index dropped 1.6%…’

An index that covers single family homes is, by definition, less precise than one that covers shares of stock in companies. With corporate shares, one share is the same as another. With homes, even in the same neighborhood, there are lots of differences. This index attempts to deal with that by tracking sales of the same home over time. Evans goes on to report:

‘…Mr. Bethune noted that today’s price declines are worse than those during the housing bust of 1990-91 that preceded a national recession. “The housing market is definitely a leading indicator of a potentially more serious downward moment in the economy,” he said.

Among the 20 cities in the S&P/Case Shiller survey, Detroit was the biggest decliner, with the average price of a home there falling 11% from the previous June. The Detroit-area economy continues to suffer from a struggling auto industry and a high concentration of risky subprime loans. “Bubble” regions like San Diego, Tampa, and Washington, D.C., where home prices had risen rapidly during the boom, all decreased by more than 7%…’

Not surprisingly, the biggest loser was Detroit. My home state of Michigan [update: where I grew up] has a stagnant economy, high unemployment and a government that does not seem to grasp the essential elements of economic development.

Update: the coastal areas have seen the most price appreciation generally, so it is not surprising that they would go down more as well. We are also seeing foreclosures rates in those areas soaring as well. However, the data on foreclosures seems to be a bit shaky (see here for more).

A Candid Letter From Oakmark Select

Kurt Brouwer August 28th, 2007

We like Oakmark Select Fund and have a lot of respect for its portfolio manager, Bill Nygren. As a shareholder in a given stock mutual fund, we always want it to do well. Obviously, no fund will do well all the time, but that’s the plan.

When we do own a fund that is not doing well, this is the kind of candid–at times brutally so–letter we hope to receive from the portfolio manager. Well actually, we hope the manager never has occasion to write such a letter, but if things aren’t going well, we appreciate the honest commentary. The full letter is here [emphasis added].

‘The Oakmark Select Fund’s performance since the end of the second quarter has been dreadful. Not only has the market declined significantly, but our Fund has fared meaningfully worse. What is especially frustrating is that this decline has not been caused by an unusual number of reductions in the earnings or growth prospects of the businesses we own. One of the primary negatives has been fear in the home mortgage market. This has caused sharp declines in the stocks of mortgage originators, and our largest holding, Washington Mutual, has been hit hard, though not as hard as many in that business…’

Dreadful is a strong word and it is clear from the opening that there will be no equivocating for Bill Nygren. I also suspect that Nygren is rethinking his very large position in Washington Mutual. Though he really like the stock, bad things can and do happen to good companies.

In any case, this letter stands in sharp contrast to letters we have seen from quantitative hedge fund managers (see here for a funny series of such letters collected by Barry Rittholtz). Nygren continues:

‘…we are also aware of how difficult this is for our investors, which is why I wanted to share this message reinforcing our approach to investing.

Oakmark’s investment philosophy is centered on the belief that in the long run, business performance and stock price performance converge. In the short run, however, stock price performance is controlled by supply and demand, which is strongly influenced by investor emotion. Those short-term disconnects create opportunity that we attempt to capitalize on. We buy businesses we believe are growing and well-managed, and we do so when we believe the company’s stock price does not reflect its real value. Then we wait. Over time, when price and value become consistent, we sell our stock and look for a new opportunity. The waiting part can be frustrating, especially at a time when our stock prices are moving in the wrong direction. But there are only two ways we can fail — we can fail if our analysis is wrong, and we can fail if we run out of patience…’

In my opinion, Oakmark Select has a solid investment strategy and strong discipline and Nygren makes it clear that he is not going to start chasing hot stocks now even though his holdings are out of favor. He also points out that his personal investments are in the Fund and so he has sufferered along with his shareholders.

‘…Finally, I can assure you that we at Oakmark remain economically aligned with you, our shareholders. Personally, I don’t own stocks except through our funds. My largest investment is in The Oakmark Select Fund, and I have purchased more shares this quarter. The last few weeks have been as frustrating as any period I’ve experienced in my career. That frustration, however, will not cause us to abandon the discipline that has served us so well for so many years. We appreciate your patience and the confidence you have shown in our investment philosophy. Prices and values will eventually converge, and we believe that convergence will be positive for our results…’

It has been our experience that even solid, fundamentally-sound funds such as Oakmark Select periodically do go through tough times. However, it has also been our experience that the fund that has been the dog of the portfolio will often turn out to be the portfolio’s darling in the not too distant future.

Update: Oakmark recently published another letter on the fund and the difficult year it is having. Here is the link, Oakmarket Select 12/18/07 Letter. Unfortunately, there has been no good news to report as the fund’s holdings are still struggling. Portfolio manager, Bill Nygren, is again quite candid and we have to applaud him for addressing the issue.

Nobel Prize Winner Becker — Qualified Approval of Fed Actions

Kurt Brouwer August 27th, 2007

Gary Becker is a renowned professor or economics at the University of Chicago and a winner of the Nobel Prize in Economics. He and Judge Richard Posner have an interesting blog that engages in dignified discussions of economic issues.

In this post, Professor Becker weighs in with qualified approval of recent actions by the Federal Reserve to inject liquidity in the financial system [emphasis added]:

‘…the Fed’s recent intervention was driven by the fear that the weakness in financial markets will spread to the real economy, and will adversely affect employment, investments, and general welfare in the United States. The same justification would apply to Europe and Asia as well. The avowed goal of such interventions would not be to help individual companies or borrowers, but rather to stabilize the complicated and interconnected economic system…

This seems absolutely correct to me. The Fed has clearly not stepped in to bail out hedge funds or others, but rather to clear up the credit traffic jam so the financial markets could get normal operations going again. Becker continues:

…Such an approach by the Fed and other central banks is not foolish, and may be right, but I believe they should continue to be guided by the criteria that have served them very well during the past couple of decades. That is, their policies should be determined by rules dependent on broad developments in the economy: unemployment, the growth in GDP, and the inflation rate. Central banks should intervene by lowering interest rates only when these broad economic indicators begin to slip badly...’

In other words, a cautious, incremental approach is best. And, heavy-handed tactics — such as the emergency reduction in the Fed funds target rate advocated by some on Wall Street — should be avoided unless the economy is clearly slipping into recession (more on whether the Fed and recessions here).

Hat tip: Greg Mankiw

Hedge Fund Woes Worry Pension Plan Managers

Kurt Brouwer August 27th, 2007

U.S. retirement assets total about $16.4 trillion these days (see here for more) and, until recently, large corporate and public pension plans were eager to put more assets in hedge funds. Due to recent failures of several prominent hedge funds, pension plans are rethinking that decision as this article by Craig Karmin at the Wall Street Journal spells out [emphasis added]:

‘Many public pension funds in recent years have become eager to invest in hedge funds. Now, some are getting cold feet.

Pension-fund managers from Louisiana to Ohio are saying they may slow their push into these funds after the recent losses suffered at big hedge funds — including ones run by Goldman Sachs Group Inc. and AQR Capital Management — have reinforced some of the risks…

Large pension plans have moved assets into hedge funds and private equity funds over the past few years. I don’t expect that move to stop completely because alternative investments such as private equity and hedge funds can add value if they are carefully selected and well-diversified. However, this movement became somewhat fad-like and so I’m happy to see a little more caution coming in. Several hedge funds have had serious problems this year (see here) and that has had an impact on how they are viewed by the generally conservative types who manage pension plans. Karmin continues:

…Dan Gallagher, chief investment officer at the Los Angeles City Employees’ Retirement System, suggests the hedge-fund losses have only made him more skeptical. “I’m not a major hedge-fund proponent,” he says. “And the perception among some of our trustees is that hedge funds are very volatile and that there is risk there.”‘

I predict that these large institutional investors will look more to mutual funds that take an alternative equity approach. The benefits of this are that mutual funds have a much more transparent structure, they generally do not use borrowing or leverage and they have a much lower cost structure.

Hat tip: MarketBeat Blog

2% Unemployment — The Greatest Story Never Told

Kurt Brouwer August 25th, 2007

We have been writing about how strong our economy is for several years now. And, even for the skeptics, the signs of a booming economy are becoming impossible to ignore.

For example, in Montana unemployment is running about 2% and some employers are having a hard time finding workers. In this AP article, AP Writer, Matt Gouras documents the difficulties of staffing in the Big Sky Country [emphasis added]:

‘…The owner of a fast food joint in Montana’s booming oil patch found himself outsourcing the drive-thru window to a Texas telemarketing firm, not because it’s cheaper but because he can’t find workers. Record low unemployment across parts of the West has created tough working conditions for business owners, who in places are being forced to boost wages or be creative to fill their jobs…

This should not be a surprise because that’s what happens in a market economy. When something is in short supply, the cost goes up.

…John Francis, who owns the McDonald’s in Sidney, Mont., said he tried advertising in the local newspaper and even offered up to $10 an hour to compete with higher-paying oil field jobs. Yet the only calls were from other business owners upset they would have to raise wages, too. Of course, Francis’ current employees also wanted a pay hike.

“I don’t know what the answer is,” Francis said. “There’s just nobody around that wants to work.”

Unemployment rates have been as low as 2 percent this year in places like Montana, and nearly as low in neighboring states. Economists cite such factors as an aging work force and booming tourism economies for the tight labor market…

The good news is that Montana was a state with high unemployment until quite recently. In fact, 15-20 years ago the unemployment rate was almost five times as high as today’s rate.

…For places like Montana, it has been a steady climb in the nearly two decades since the timber and mining industry recession. The state approached double-digit unemployment levels in the 1980s and began the slow crawl back in the early 1990s.

“This is actually the biggest economic story of our time, and we don’t quite grasp it because it is 15 years in the making,” said economist Larry Swanson, director of the O’Connor Center for the Rocky Mountain West at the University of Montana…’

Business is booming in Montana and other western states. This story paints this condition as a negative, but it’s not. Employers are complaining because they cannot find workers, but what that really means is they cannot find workers at the rates they want to pay.

So, they have a choice. Slow down the growth or pay up a bit. Either way, it’s a good problem to have. Much better than what they faced 15 years ago when there was little or no business to be had.

We are in the greatest economic environment this country has ever had. I hope we appreciate it. Long may it last.

Hat tip: BrothersJuddBlog

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