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Harry Newton's In Search of The Perfect Investment Technology Investor. Harry Newton

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9:00 AM EST, Tuesday, April 21, 2009. No question, earnings for the first quarter are awful. There was hope that everything was written down in 2008 and it would only be up from the very low base. Hence, the March rally. See below for "Awfully Familiar." Meantime, yesterday the Dow fell a whopping 3.56%. Porter Stansberry of Stansberry & Associates, investment research, writes (my bolding):

The garbage rally comes to an end... Will Macerich crack $20?... What Bank of America's numbers leave out...

+ The rally in stocks since early March included a bunch of garbage. I have a spreadsheet of about 400 companies with more than $100 million in market capitalization that are overleveraged, unable to refinance, and unable to meet their debt-service payments from earnings. They're like lit matches. It's only a matter of time until they burn out.

You've seen me write about many of these stocks over the past six months – General Growth, Macerich, MGM, etc. But since March, nearly all of these stocks have posted huge gains. Many subscribers, I'm sure, thought that meant my analysis was wrong. Nope. The stock market is a fickle beast... and it's never easy to make money on any trade – even when all of the facts and the circumstances are lined up in your favor.

+ What's happened with shorting these overleveraged companies is that too many people put too much money on the short side. When a position gets that unbalanced, it's sure to "snap back." In fact, over the last six weeks, companies with the most debt and the lowest returns on assets turned in their best six-week performances since 1938. Says Bloomberg: "The 130 companies in the S&P 500 and Europe's Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero... rose an average of 82 percent from March 9 through April 17."

So the worst companies' stocks did about four times better than average during this rally. Meanwhile, nothing improved with the fundamentals of these businesses, most of which remain deeply troubled. How do you explain the worst stocks doing so much better than average? A short squeeze. The speculators holding these heavily shorted stocks were forced to cover. Reports coming from momentum hedge funds suggest their first-quarter losses were significant.

+ Let's look at one situation in particular – Macerich, the mall owner whose competitor, General Growth Properties, recently filed for bankruptcy. Macerich owes $6.7 billion in debt – mostly in the form of mortgages on its malls. It acquired most of its portfolio in 2002-2006, when real estate was extremely expensive relative to rents. (Macerich spent $2.3 billion for the mall owner Wilmorite Properties in late 2004; it bought another mall owner, Westcor, for $1.5 billion in 2002.)

But now mall vacancies are soaring. According to mall research firm Reis, retail tenants vacated 8.7 million square feet of space in the first quarter of this year, on top of the 8.6 million square feet vacated in all of 2008. Mall vacancy rates are now nearly 10% – a record increase from last year. Given the current market, Macerich won't be able to sell property for anything like the prices it paid. Assuming it could get 50 cents on the dollar, its asset base isn't worth the $6.3 billion it claims on its balance sheet. It's probably worth more like $3.1 billion. And that means it can't sell enough property to pay down its debts.

+ And that's not the worst part. The real problem is Macerich can't afford the interest on its debts. The analysis is simple: Macerich takes in rents. It pays for its overhead, its interest, and the upkeep in its buildings. It brought in $537 million in rent during 2008. It spent $16.6 million on overhead and $277 million on upkeep. That left $243 million for interest. But interest expense was $281 million.

+ My bet is the great garbage rally of 2009 is finished. While I expect high-quality companies with good businesses to continue to do well, I don't expect companies like Macerich or any of the other overleveraged companies to make it out of this recession. They're going bankrupt. It's only a matter of time.

+ Bank of America today announced earnings of $4.25 billion for the first quarter – more than it made in all of 2008. Mmmn... Where did the money come from?

Well, $1.9 billion in net income came from the sale of China Construction Bank (CCB) shares. And $2.2 billion came from marking up Merrill's book of mortgages. If you subtract these one-time gains and special accounting adjustments, Bank of America actually lost $1.3 billion.

+ It has always seemed strange to me that public investors put up with all of the accounting nonsense that goes on in public companies. I'd never own a stock whose CEO couldn't tell me in plain English whether or not the company had made or lost money. I mean, Warren Buffett, who controls an enormous holding company and some of the world's largest and most complex insurance companies, somehow manages to explain what's happening each year using plain English and remarkably few numbers -– all of which are simple and intuitive. Why can't everyone else?

+ Here's what Bank of America (and the government) don't want you to know: Credit quality deteriorated across all of its businesses and loan portfolios. Nonperforming assets increased to $25.7 billion from $18.2 billion last quarter and $7.8 billion year over year. To protect itself from future losses, the bank increased its provision for credit losses to $13.4 billion from $8.5 billion, including a $6.4 billion net addition for loan and lease losses.

Shame on you. You still haven't watched the Margaritville episode of South Park. Drop everything and laugh (or cry) yourself silly. If you're having trouble watching it, turn off your browser's blocking of popups.

Awfully Familiar. From a site called "Financial Armageddon -- Insights on debt, derivatives, government guarantees, the retirement system and the coming economic unraveling."

These days, lots of people seem to be reading from the same script:

"CBI Says Worst of British Recession Over" (Reuters)

"China's Premier Says Economy Better than Expected" (Associated Press)

"Dubai's Ruler Says the Worst Is Over" (Financial Times)

"U.S. Officials Suggest Worst of Recession Is Over" (Reuters)

"Italy Employers See Signs Worst Over in Crisis" (Reuters)

"Worst Over? Just Maybe" (Associated Press)

"'Worst Is Over; India to Be on Recovery Path in 2-3 Quarters'" (Business Line)

"US Hopes the Worst Is Over" (The National)

Hmmm, those words sound awfully familiar...ah, yes, now I remember:

"Lehman CEO Says Worst Is Over, Yet Troubles Ahead" (Reuters, April 16, 2008)

"Bear Stearns Says Worst Is Over After Writedown" (CNBC, November 14, 2007)

"Citigroup Chief Says Worst of Crisis Is Over" (Evening Standard, May 7, 2008)

"Legg Mason's Miller Sees Recovery for Stocks; 'Worst Is Behind Us,' Famed Fund Manager Tells Beleaguered Shareholders" (MarketWatch, April 23, 2008)

"Is the Worst Over for Detroit?" (SmartMoney, July 18, 2005)

Irrational Exuberance. Human emotions cause booms and busts. This is a review of a new book called ANIMAL SPIRITS: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof and Robert J. Shiller. The review appeared in Sunday's New York Times Book Review.

Irrational Exuberance
Look around you, George A. Akerlof and Robert J. Shiller say. The second coming of the Great Depression is, like the original, a direct result of animal spirits. If only we had factored those turbulent emotions into economic theory, we might not be repeating the earlier tragedy.

Akerlof, a Nobel laureate, and Shiller, a good bet to become one, are prominent mainstream economists. They don’t deviate easily from orthodox theory, with its allegiance to the proposition that people are essentially rational, well informed and unemotional in the numerous transactions that shape the economy. But in “Animal Spirits,” they have deviated — and they have done so just as mainstream theory self-destructs.

There was nothing rational, well ­informed or unemotional about the behavior that has all but collapsed the economy. That leaves most of America’s economists without a believable framework for explaining how we got into this mess. Akerlof and Shiller are the first to try to rework economic theory for our times. The effort itself makes their book a milestone.

Keynes performed a similar service in the 1930s — mainly by making the point that market economies could suffer long periods of high unemployment and low output unless government stepped in to supply the necessary demand. Barack Obama’s $787 billion stimulus program reflects his insight.

But another aspect of Keynes’s thinking did not fare well. He also introduced the world to “animal spirits,” coining that phrase to describe a range of emotions, human impulses, enthusiasms and misperceptions that drive economies — and ultimately unwind them. The economists who interpreted Keynes “rooted out almost all of the animal spirits — the noneconomic motives and irrational behaviors — that lay at the heart of his explanation for the Great Depression,” ­Akerlof and Shiller declare.

Addressing this wrong, the authors attempt to restore animal spirits to economic theory. They do this by drawing on the greater understanding of human psychology that exists today, and which Akerlof and Shiller, along with other economists, have incorporated into the relatively new field of behavioral economics.

Until now, behavioral economics has focused mainly on a variety of disparate traits that chip away at the assumption of rationality embedded in mainstream ­theory. A young person, for example, fails to join a 401(k) plan, even one subsidized by his employer, although if he were ra­tional and fully informed, he would certainly sign up.

What Akerlof and Shiller do is to highlight this sort of finding, packaging it with numerous other psychological insights into a half-dozen broad maxims that permanently alter the concept of rational behavior. And their book takes their case not just to economists, but also to the general reader. It is short (176 pages of text) and easy enough for laymen to understand (most of the time).

Above all, they challenge the reigning free-market ideology of the past 30 years or so, from the rise of Margaret Thatcher and Ronald Reagan to the abrupt arrival of the present crisis late last year. That ideology held that markets should operate free of government because they were rational. But if animal spirits influence behavior, then government must play a broad, disciplinary role, and do so permanently.

Akerlof and Shiller spent five years writing “Animal Spirits” and honing that conviction. They are concerned that once we enter a revival, pressure will inevitably build — just as it did in the late 1970s, more than a generation after the Great Depression — to give the markets free rein again. Akerlof and Shiller intend their book as an obstacle to that ever happening.

“The system of safeguards developed from the experience of the Great Depression has been eroded,” they write. “It is therefore necessary for us to renew our understanding of how capitalist economies — in which people have not only rational economic motives but also all kinds of animal spirits — really work.”

Both men are old hands at prodding their fellow economists into recognizing exceptions to mainstream theory. Akerlof, a professor at the University of California, Berkeley, shared a Nobel Prize in 2001 for his work on “asymmetric information,” which means that some parties to a transaction know more about the deal than others, like the used-car salesman who knows more about the shortcomings of the vehicle he is trying to sell than the customer he is pitching. Lemon laws, protecting consumers, grew out of such findings. Akerlof has long believed that in most market situations a government role can improve the outcome. “Animal Spirits” brings that view to a high boil.

Shiller, a Yale professor, originated the phrase “irrational exuberance” before Alan Greenspan made it famous, and in his research he has documented the rise and fall of home prices going back decades, to demonstrate that the latest surge was far and away the greatest in American history. The bubble will burst with very unpleasant results, Shiller warned, well before that actually happened.

What are these animal spirits that drive the American economy? Confidence is one. Far from dispassionately weighing and analyzing all the options, people act on the confidence, or overconfidence, that a home they are about to buy will be worth more a year later. Confidence drove up stock ­prices in the 1920s and again in this decade, far more than corporate balance sheets and pure reason would justify, and now lack of confidence, spreading like a contagious disease, is exacerbating the sell-off.

Fairness also shows up as an animal spirit, influencing thousands of decisions in ways that part company with standard theory. Out of a sense of fairness, for example, bosses often pay their employees more than the market demands. “Considerations of fairness are a major motivator in many economic decisions,” Akerlof and Shiller write, “and are related to our sense of confidence and our ability to work effectively together.”

Corruption, too, is an animal spirit. This includes the propensity to produce not just what people really need but what they think they need, like the mortgage-backed securities, “a modern form of snake oil,” the authors declare.

In their list of animal spirits, the two economists pay special attention to the tendency of people to think in terms of narratives or stories. “High confidence tends to be associated with inspirational stories, stories about new business initiatives, tales of how others are getting rich,” the authors write. On the other hand, ­stories about the Great Depression shape our narrative of what is happening now, and our behavior.

So what is to be done? Animal spirits are human emotions; they can’t be turned off. Unchecked, they drive the economy into misbegotten booms and disastrous busts. Tempered by government, on the other hand, they are a great source of entrepreneurial energy, safely channeled into a healthy capitalism. Keynes came to that conclusion, and Akerlof and Shiller, in “Animal Spirits,” push hard in the same direction — prodding their colleagues to follow their lead in revamping economic theory to deal with a market system that, quite irrationally, failed to govern itself.

Neuroenchancing drugs get into the colleges: My God. Another drug epidemic. The latest New Yorker has a totally fascinating piece called "Brain Gain." It begins.

A young man I’ll call Alex recently graduated from Harvard. As a history major, Alex wrote about a dozen papers a semester. He also ran a student organization, for which he often worked more than forty hours a week; when he wasn’t on the job, he had classes. Weeknights were devoted to all the schoolwork that he couldn’t finish during the day, and weekend nights were spent drinking with friends and going to dance parties. “Trite as it sounds,” he told me, it seemed important to “maybe appreciate my own youth.” Since, in essence, this life was impossible, Alex began taking Adderall to make it possible.

Adderall, a stimulant composed of mixed amphetamine salts, is commonly prescribed for children and adults who have been given a diagnosis of attention-deficit hyperactivity disorder. But in recent years Adderall and Ritalin, another stimulant, have been adopted as cognitive enhancers: drugs that high-functioning, overcommitted people take to become higher-functioning and more overcommitted. (Such use is “off label,” meaning that it does not have the approval of either the drug’s manufacturer or the Food and Drug Administration.) College campuses have become laboratories for experimentation with neuroenhancement, and Alex was an ingenious experimenter. ..

You can read the entire fascinating piece on the New Yorker's web site.

How to be, and not to be an entrepreneur. As I wrote yesterday, "Startups are our ecnomy's growth engine. Business schools are running business plan competitions. " One lady reader said she was going to encourage her local business school to run a contest.

If you're close to your local business school, please encourage them also.

Guide Dog. I sat next to a woman with a dog on her lap. I asked how she got it on the plane. She said she had a medical certificate to "prove" she needed the dog with her 24/7. Our conversation reminded me of this wonderful joke:

Two women were out for a Saturday stroll. One had a Doberman and the other, a Chihuahua. As they walked down the street, the one with the Doberman said to her friend, 'Let's go over to that bar for a drink.'

The lady with the Chihuahua said, 'We can't go in there. We've got dogs with us.'

The one with the Doberman said, 'Just watch, and do as I do.'

They walked over to the bar and the one with the Doberman put on a pair of dark glasses and started to walk in.

The bouncer at the door said, 'Sorry, lady, no pets allowed.'

The woman with the Doberman said, 'You don't understand. This is my guide dog.'

The bouncer said, 'A Doberman?'

The woman said, 'Yes, they're using them now. They're very good.'

The bouncer said, 'OK, come on in.'

The lady with the Chihuahua thought that convincing him that a Chihuahua was a guide dog may be a bit more difficult, but thought, 'What the heck,' so she put on her dark glasses and started to walk in.

Once again the bouncer said, 'Sorry, lady, no pets allowed.'

The woman said, 'You don't understand. This is my guide dog.'

The bouncer said, 'A Chihuahua?'

The woman with the Chihuahua blurted out, 'A Chihuahua! They gave me a Chihuahua?'

P.S. I have no clue how to make money in this market. To my tiny brain, I continue to worship two idols:

1. Cash is King.

2. When in doubt, stay firmly OUT."

I pray I'm learning something by writing this column. I certainly spend enough time on it.

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.