In Search of the Perfect Investment

Suddenly, high yield is no longer in.  Maybe. The world’s worst trade has suddenly become profitable (if you bought recently).

Suddenly, the press (and all my friends) are full of bond horror stories. Of muni bonds cratering because their prospects are bleak. Of popular high yielders like Annaly, which drops its quarterly dividend from 68 cents to 64 cents. And took a hit:

Short-term panic is in full mode.

How “heavy” yesterday’s hit was a function of how much NLY you owned. In my case. a bunch. I felt like an idiot. But then I consoled myself with NLY’s chart this  year:

It’s gone down before and come  back. And heck, I bought the thing (and my muni bonds) for yield. For income. For cash to live on  For cash to pay my dentist. Yes another crown. Another three months for his daughters in college. NLY now yields 14.4%. That’s a nice return. One should be able to take considerable gyrations for that pleasure. And maybe buy a little more on the dip.

Annaly itself reognizes our new world. Their latest monthly December commentary starts:

We are currently accepting reader submissions for new synonyms for “choppy” or “uneven,” which is still the operative description for the US economy.

Larry Doyle writes:

Interest rates globally have moved up approximately 50 basis points (.5%) over the last month with the bulk of that move having occurred in the last week. What is going on? What is driving this move higher? A harbinger of better days ahead or an indication that the massive deficits in selected nations will require higher rates to attract capital? Or both of these reasons and a lot more. Let’s navigate.

1. First things first, even with the backup in rates recently, let’s be cognizant that for the year the 10yr US Treasury rate is lower by approximately 50 basis points.

2. What global bond market has had the biggest rout recently? Spain. Spanish 10-year bonds have backed up almost a full 100 basis points (1.0%) over the last month.  Overnight Spain was put on a watch list by Moody’s for a potential downgrade. While the fiscal mess in Ireland is off the front page for the time being, the massive fiscal deficits in the peripheral nations of Europe remain and will definitely require higher rates to attract capital. As European bonds sell off, our bond market is not about to stand still.

3. Improving emerging economies will need to continue to raise rates in order to stem the prospects of higher inflation. That reality will drive rates higher globally as well.

4. What domestic issues are driving our rates higher? I see two major factors:

>The municipal bond market is backing up quickly as the Build America Bond program will very likely be discontinued. That reality is causing a wave of supply to hit the market prior to year end. Investors are demanding higher rates to fund these deals.
>The likely passage of the tax package extending the Bush tax cuts is viewed as an economic positive BUT also a net negative in terms of increasing our deficit.

The BIG question for investors, though, is whether this increase in rates is a reflection of real structural improvement in our underlying economy and will we see job growth? The jury remains out on that question–but call me doubtful.

I would ask, if the economy is improving, WHY does the Fed still see a need for quantitative easing. Additionally, is the market sending a major middle finger salute to Ben Bernanke and Tim Geithner? I believe so. How’s that? Even in the face of the Fed being a $600 billion buyer in the market, our rates are headed higher to attract REAL money and REAL investors to fund our massive federal and municipal deficits.

Additionally we should be aware that a government–that being the US of A–that is willing to devalue its currency–and it is–in order to deal with its deficit is a much higher risk for investors.

Navigate accordingly.

In short, no one knows precisely what is happening. The “New Normal” is the old fickle. Expect the road ahead to be rocky. I stick by my double mantra:

1. Cash is king.

2. High-yielders still make sense. Keep your stops on these to about half their yield. That should protect you, in case your neighbors become even more panicky.

The great news. Internet startups are alive and well. You could do worse than focusing your attention on finding the next great Internet startup. The Internet is not your father’s steel company, which needed zillions of dollars of factory  investment. Think of an idea now, you can have your Internet startup running by this afternoon — for an “investment” of under $100.

Should you have a really great idea, dozens of venture capitalists and private investors stand ready to fund you. You won’t have to start in a garage. For motivation (as if my readers need motivation),

The Wall Street Journal has a piece, Ex-Google Chefs Cook Up a Start-Up of Their Own. Click here.

From the New York Times Dealbook today comes this:

Twitter’s Value Rises to $3.7 Billion After New Investments Here’s a news flash fit for a tweet: Twitter, the social media darling, is now worth $3.7 billion after a new $200 million round of investments.

And James Surowiecki of the New Yorker has this:

The history of the Internet is, in part, a series of opportunities missed: the major record labels let Apple take over the digital-music business; Blockbuster refused to buy Netflix for a mere fifty million dollars; Excite turned down the chance to acquire Google for less than a million dollars. Time and again, businesses with seemingly dicey prospects have ended up becoming huge successes, and price tags that once seemed absurd have turned out to be bargains. But big companies have learned their lesson: these days, they’re positively obsessed with not missing the next big thing, and are willing to shell out huge sums of money in order to insure that they don’t. And when Google tried recently to acquire the two-year-old daily-deal site Groupon, for the seemingly outlandish sum of six billion dollars, it was hard not to wonder if the lessons of history had been learned too well.

To be sure, Groupon’s got a healthy business. Almost forty million people, in more than a hundred and fifty cities around the world, have signed up for its e-mails, and every weekday it sends subscribers a daily deal, typically from a local business—fifty per cent off spa treatments, say, or twenty bucks off sushi. Groupon’s gimmick, such as it is, is that you get the deal only if enough people sign up for it, but at this point the site is so popular that just about all the deals go through. In essence, what Groupon offers is an innovative twist on the tradition of loss-leader marketing: just as retailers have always used steep discounts on certain items in order to get people into their stores, Groupon’s deals are an easy, low-risk way for small businesses to attract new customers. It’s an appealing business model, particularly in recessionary times. But is it, as Groupon’s C.E.O., Andrew Mason, suggested recently, a company that’s going to transform the way local business works? Or is it just another overpriced flash in the pan?

The answer, most probably, is neither. Groupon isn’t going away. Unlike many Web companies, it’s been profitable from the start. (It takes fifty per cent of the revenue in every deal.) This year, it had half a billion dollars in sales, and estimates are that, before long, it could have as much as two billion dollars in revenue. The market for local advertising, which is really the business Groupon is in, is huge (more than $130 billion a year) and still relatively untapped online. And, while Groupon has many competitors, it’s by far the biggest and most respected player around.

So Groupon is a real company. But it seems unlikely that it’s going to become a revolutionary company, along the lines of YouTube, Facebook, Twitter, and Google. Most of the companies that have transformed the Web have certain things in common. They have distinctive technologies. They benefit from what are usually called network effects: the more people who use the service, the more valuable the service becomes. (You’re more likely to use Facebook or Twitter when lots of your friends have signed up, and the more people there are who use Google the more accurate its searches become.) Most important, they scale easily, meaning that they can grow very big without much additional effort. To be sure, the more users Twitter and Facebook have, the more servers they have to buy, and so on. But the genius of these companies is that their users do most of the work and create most of the value; once the ball is rolling, it’s the users who keep pushing it along.

Groupon, by contrast, is a much more old-school business. It doesn’t have any obvious technological advantage. Its users don’t really do anything other than hit the “buy” button. And its business requires lots of hands-on attention: thousands of salespeople to sell to and service local businesses, copywriters to come up with the right pitches for customers (Groupon’s clever ad copy is one of its selling points). Groupon isn’t just flinging piles of deals at users; the idea is that it’s performing a “curatorial” role, and is relying on humans, instead of on Google-style algorithms. All these things are real assets—and a reason that Groupon is less vulnerable to competition than people think—but they’re also very labor-intensive. Facebook, with five hundred million users, has fewer than two thousand employees, while Groupon, with some forty million subscribers, already has three thousand employees. Groupon can obviously add subscribers easily (all it has to do is send out more e-mails), but serving them enough deals to keep them happy is another matter: the more business it does, the more people it has to hire. Recently, Groupon has experimented with a self-service system, which would let it outsource some of the work to local merchants, who could set up virtual storefronts. But, unless it wants to abandon the approach that made it successful, scaling up will require more work and more workers than the Twitters and YouTubes of the world need.

This isn’t an impossible task; Amazon succeeded in the face of similar obstacles. But, even if Groupon doesn’t end up changing the way we shop, there’s still a good chance that it will make a lot of money—maybe even more than some of its revolutionary brethren. When we think about the Internet, we often think of businesses in black-and-white terms: either they’re huge, world-changing hits or they’re flops. But that’s a false dichotomy. These days, the Web is full of good, solid businesses that may not be remaking the world but that are helping give people what they want. If that’s what Groupon ends up being, well, there are worse fates. ♦

Opportunities at the post office.
A lady is at the post office buying stamps for her holiday  cards.  “May I have 50 Chanukah stamps and 50 Christmas stamps?”

The clerk answers, “What denomination?”

“Oh my G-d!” the woman exclaims rhetorically. “Has it REALLY come to this? Give me 16 Orthodox, 22 Conservative and 12 Reform Chanukah cards and 20 Catholic, 18 Greek Orthodox and 12 Lutheran Christmas cards.”

Harry Newton who is learning to divorce emotion from this business of investing. It ain’t easy. Heck, it’s only money.