Daily Dose of Optimism

2006 Predictions: What To Expect When Real Estate Foreclosures Spike (in 2007-2008)

The NY Post had an article a while back that said that NYC foreclosures had risen 8% in the month of March.

I did a little extra research on this article to fill in the blanks, and found interesting, but perhaps expected, disparities in foreclosures amongst the five NYC boroughs. (Note: the overlap between "county" and "borough" may not be perfect.)

Basically, Staten Island has foreclosures on 1 in 700 properties. Manhattan has foreclosures on 1 in 15,000 properties.

I interpret this data to mean that when real estate foreclosures really start to spike, it will probably be a phenomenon disproportionately occurring in lower income neighborhoods. The 1980s gave us trickle down economics; the housing boom could give us trickle up recession. - Ed

NYC Foreclosure Rates - March 2006

• NYC Overall: 1 in 1,313
• Staten Island: 1 in 698
• Brooklyn: 1 in 1,230
• Bronx: 1 in 1,529
• Queens: 1 in 2,454
• Manhattan: 1 in 15,963

2006 Prediction: America as World Savior Peaks in 2006

Ed's 2006 prediction:

America's attempts at being a world savior will peak in 2006, decline in 2007 and look pretty grim by 2008.

I am using the Time Magazine cover indicator as my key data point for this prediction, with Time's notable precedent for top-calling being Jeff Bezos, Time's 1999 man of the year.

For 2005, Time's Man of the Year was a triumvirate of folks whose personal wealth was achieved by selling homogeneous products to a mass audience: Bono, Bill and Melinda Gates. (I'll try to overlook Melinda Gates' place on the cover as a role model for women: do whatever it takes, including studying science, to marry rich.)

I generally have a hard time getting excited when celebrities decide the only way to make their lives more meaningful is to solving the problems of people they otherwise have no connection with whatsoever. What is the average American  - neck deep in debt, with average wages stagnant over the last 30 years - really supposed take away from the largesse of the mega-rich overseas? Americans already give away the store to third world countries, as long as those countries are willing to do something useful in return - like run a factory. And I'm not sure that the unmitigated outbound flow of wealth from the US is a something to celebrate. 

The types of problems celebrities like to solve almost always have root causes that are so significant, their efforts will only ever amount to the equivalent of a weekend of pushing Sisyphus's rock, always in front of admiring cameras. We, as largely silent and unquestioning consumers of this information, are culpable in allowing them to perpetuate these charades. We want to believe that building another America is easy, and don't want to stop and consider what it actually took to get what we have.

I see America in this way: not only does America enjoy an unparalleled natural bounty in terms of climate, fertile land, and natural resources for our use, but we were also fortunate to have been guided at our founding by advanced political thinkers willing to organize muscle behind their beliefs.

As we rarely stop to consider this potent combination - good people, good ideas, and good land - we foolishly believe people who try to tell us that the reason other countries remain poor or backwards is because of "Factor X," or "Factor Y," and if we could only find the right band-aid, they could become like America...and buy lots of copies of Microsoft Windows, and U2 Cd's...

I've ranted enough. Let me explain how I came up with my prediction:

One of Bono's big platforms is debt relief. (Regular readers can probably see where I'm going with this already.) Although Bono has since branched out into other causes, debt relief was the issue that got him going, and remains a core plank in his platform.

Now, I would just like to highlight the irony of a major US publication highlighting the philanthropic work of an individual who is asking the largest debtor nation on earth to forgive the debts owed to it by other countries.

In two or three years, quite plausibly the US government will be asking other countries the same thing. Hence, Bono in 2005 is Jeff Bezos in 1999. Celebrated not quite at the top, but just before it. - Ed

2006 Predictions: Hedge Fund Doomsday in 2010 (McKinsey)

If Ed says something like "over time, institutional investors are going to realize that at least half of all hedge funds do not justify their performance overhead," it is simply added to the pile of ramblings already here on the blog.

If McKinsey says the same thing, and puts a date on their prediction, well, that's news! Institutional Investor has the scoop:

Considering all the naysayers who have long predicted the demise of hedge funds for one reason or another, one may not take seriously the latest dreary forecast from McKinsey & Co. However, the consultancy does make some points that may serve as survival tips for the future. “We expect the recent proliferation of hedge funds will stall and then reverse itself by 2010,” the report says.

The bottom line: Investors are getting wise to HF managers. McKinsey cites Bridgewater Associates research which found that hedge funds that invested in five strategies couldn’t beat a synthetic passive index. And once institutional investors – the biggest source of HF flows these days – realize that, they will “be unwilling to pay for it. Instead they will switch to the true (and fewer) generators of alpha.”

According to McKinsey, those relying too much on producing beta are going to run up against competition from other beta-users, such as quantitative managers, while traditional managers will increasingly look to maximize returns by exploiting leverage, just as hedgies do. “Investors will realize there is no such thing as a hedge fund asset class,” Bridgewater founder Ray Dalio told Financial News.

(I like this phrase: "the true generators of alpha." If I had no idea what that actually meant, I could see an alt-rock band using this for a name.)

McKinsey's original report is on the web here. The passage referenced above is on page 28-29.

My thoughts: In order for institutional investors, a group with the thought process of a pack of lemmings but the momentum of an avalanche, to decide that the hedge funds they've chosen were the wrong place for their assets, I see basically two scenarios:

1. Rational realization they are overpaying for average performance
2. Rational realization they are $500 million in the hole with retirement obligations to fill

Which do you think is more likely?

In the first scenario: assuming the hedge fund didn't blow up, an average hedge fund will say that his returns are due to superior risk management with lower volatility, and an above average hedge fund will say he's just smarter than everyone else.

Because both of those explanations would quite plausibly placate an investment committee, I think the only way McKinsey's prediction comes true is in the second scenario, which requires another major bear market. That way, poor performance and a need for cost cutting will dictate the changes. Just count me as skeptical that there will be an influenza of rationality among the asset allocator community.

Regarding predictions in general, I only put dates on macro events to amuse myself, but perhaps if I took it more seriously, I could make a career out of it. See "2006 prediction: real estate bubble a 2007 item" for my last attempt at reading the macro-economic crystal ball. - Ed

2006 Prediction: Blogs to be Taken Seriously in 2006

Paul Kedrosky had a prediction for 2006 up a while back that said:

All this low-rent schadenfreude [by bloggers at the expense of MSM] will come back to haunt bloggers in 2006 when a major blog is hit with correct Blair-esque allegations of having twisted the truth and made shit up.

I don't think this idea has real legs to stand on, but I do have a prediction and some related thoughts:

Ed's 2006 prediction:

We will see blogs taken seriously, both by readers and MSM, and ported to other forms of media, notably TV, and in a major way - not just via talking head appearances.

By this, I mean finding the best bloggers and putting them on CNBC, Meet the Press, or even giving prolific and personable bloggers their own TV shows. There is probably a Conan O'Brien type talent in the works out there right now.

Newspapers will run an entire section that re-prints blog posts for off-line reading. Previously unknown bloggers will get book deals. (That already happened! Ed: I mean people who write about things other than the embarassing details from their sex life...)

Now, my prediction is a little easy here: the move towards putting good bloggers into other media formats is already starting!

Instead of simply reading the rambling genius of Mickey Kaus, I am also now able to watch and hear him on Bloggingheads.tv. (Of course, it's on a blog right now, but that could change.) I find Kaus is actually more entertaining on screen than in print.

The move is simple and logical. If I like reading someone's work, there's a decent chance they're as interesting in person as well.

Here's what I think doesn't work about Kedrosky's prediction that a major blogger will fall from making stuff up:

(1) Other than triumphalism in support of the Iraq war, it's hard to imagine a topic where a blog could suffer a scandalous downfall on a scale large enough for enough Americans to need know via a major media outlet. (Unless it's a blogger-murder, a blogger-insider-trading scandal, or it turns out that one of those "Iraqi bloggers" is really Donald Rumsfeld.) That no blogger would suffer for Iraq makes sense to me, as it would require first implicating the President, Congress, CIA and about 95% of the media first.

(2) There's not much room to fall in reputation if you are an active blogger. Other than the fact that a blog can earn a regular, loyal reader base of people united in their generally high intelligence and refusal to pay for information - unless you're independently wealthy or running a publicity-hungry startup - can there be a more debased position for an intelligent and accomplished person to be in than to devote a significant portion of their time putting out their opinions for others to read...for free...in a forum where anyone can reach out and pee on their work?

Where's the reputation from which to suffer a reputational loss? The greatest penalty a blogger can suffer for putting out free ideas is obscurity. A once great blog whose reputation is tarnished would become like any newbie blog that, in general, no one pays attention to unless you had some notoriety in your former life.

What tends to happen to blogs - with almost a depressing regularity - is that major blogs simply start to suck. Usually this stems from a loss of humility, driven by hit traffic, with generally drives them to believe that because they posted something, people will care about it. (Ed: Which explains why I insist on toiling in obscurity...)

(3) If there was a major error on a blog, another blog would be the one to call them out on it. If a blog corrected the major error...one blog would gain status while another lost it...so the blogosphere preserves its overall integrity. Mainstream media is definitely not going to correct a factual blog error on national media for a few reasons, primarily because MSM assumes most blogs are just error-prone ramblings anyway.

But here's another idea: when and if the MSM pays attention to an individual blog, it's like focusing the sun through a magnifying glass on an ant. The traffic spikes like you wouldn't believe. The blogger's ego is inflated to the point of exploding... hence, as a survival strategy, it would make sense for MSM to continue to ignore existing blogs while creating their own, "closed loop" blogs (see: RealMoney.com blogs, BusinessWeek blogs, WaPo blogs, etc.), hoping that the mass of the public doesn't recognize the fact that they're being conned by these almost-blog offerings.

So, 2006 is the year of blog TV - bring it on! - Ed

2006 Prediction: A Thesis for Re-Invigorating the News Business (GCI, CBS, KRI, NYT, WPO)

It's clear that something isn't right in the news business, but in contrast to those who think that major news outlets are toast, I offer this prediction:

2006 will see important steps by news companies to turn the tide, re-invigorate their businesses and grow readership, and a few will even find a new formula to succeed at this for the long haul.

I think this may be fairly obvious, as MSM (Main Stream Media) firms have so many advantages that they don't exercise well enough. For starters:

• Journalists are paid to write
• Full time news gathering and editorial staff already in place
• Expertise in layout and printing of hard copy information
• Physical distribution nationally and/or locally
• Typically have established web presence
• Recognized and generally trusted brands

However - and this is the reason why blogs are sprouting up like weeds in an untended sidewalk - MSM has significant things that are working against it:

• By design, journalistic writing conventions are fragmented, repetitive and dull
• Major papers routinely confuse "quality" with length
• Multiple editors are one or more steps removed from writers and either err on the side of blandness or make errors that can only arise from not being familiar with a subject
• By seeking to be "definitive" on every subject there is inevitably a lot of hemming and hawing while one is "first" but incomplete on facts
• Articles are generally written with the assumption that readers don't know much about a topic
• There are unwritten, but widely shared "truth codes" about how topics can be discussed, and what can be said about them; journalists can be penalized severely for violating them
• Most journalists think that the primary way in which they fail to serve the public is their inadequate criticism of conservative politicians

That said, I think the problems faced by MSM firms have a clear source: an oversupply of institutional voices exhibiting the characteristics as above. This can be rectified as firms go out of business, consolidate, or figure out new approaches to communicating news.

There is a big opportunity for a mainstream company to buck the conventions of "how to talk about the news" and by setting new protocols, to win new readership. Love it or hate it, Fox News has responded to this imbalance of supply and demand, and provided an alternative. Now, Fox gets ratings that are greater than the sum of all its cable competitors in most of its time slots.

Although it is "cool" to say that Fox is propaganda, surely any investor worth their salt can appreciate that when a body is as monolithic in opinion as media is in the US, that there is something vital being overlooked. Blogs are evidence of this - a good blog is about meeting the need for interpretations of news and events, to spare readers from a doomed life of reading stale AP "toe-the-party-line" articles.

Certainly, it couldn't be hard for a news intermediary to figure out how to freshen up its writing, and to re-jigger its coverage such that they avoid putting us to sleep, or falling into the same old biases that characterize news media today. I think this is an issue of tweaks to a business model that otherwise has all the right infrastructure in place, right now.

Most of my news originates from MSM, as I expect it will 50 years from now. That doesn't mean the press will be exactly the same, but firms with an advantage today have every opportunity to retain that advantage tomorrow...if they want it.

The question for investors: which management team, at which firm, has the gumption to get this right? - Ed

2006 Prediction: Accounting Fraud Not Going Anywhere

Ken Fisher has some good points on why accounting quality will stay at about the same quality, or deteriorate, unless the government breaks up the major firms in an anti-trust action. Key points:

• "No real competition among auditors anymore. With very few exceptions the auditor of almost any public corporation can't be fired and replaced. [...] As in any other field, an absence of competition begets a deterioration in quality."
• "By 2002 a merger wave had shrunk eight [major accounting firms] to five. Just two regionals, with a combined 1% market share, did any significant number of audits of public companies: BDO Seidman and Grant Thornton. Then the government, in its infinite wisdom, decided that since Arthur Andersen employed one or two bad auditors, the entire firm should be destroyed."
• [Ed: See this link for the gory details on how concentrated US audits are...]
  
• "In any other field the government would break the foursome into the Big Fourteen. We'd have Touche competing with Delo and Delo with Itte. Not here. The regulator of the auditing industry, the Public Company Accounting Oversight Board, likes the clubby and confined marketplace."

For more on accounting industry reform, see this Alex Berenson excerpt. Fisher's full comments are below. - Ed