“Relentless Pursuit” is a year in the life of 4 young Teach for America (TFA) teachers working at a tough, inner-city school. But once the surface was scratched it became clear that it was a launching pad for a Wendy Kopp presidential bid. Wendy is the courageous founder of TFA and not the center of this book. However, no description of the TFA program would be complete without including her. I should disclose that I was a freshman at Highland Park High School when she was a senior. I don’t remember her. I vaguely remember hearing about some wonder girl who sewed her own clothes and won every academic prize known to man. This book portrays her as a miracle worker and a Mother Theresa for the underprivileged learners. She’s got a great sense of humor, too. I guess I’ll have to borrow her book from the library (if I can remember). She has pulled off something inspiring with her TFA Organization. Too bad she doesn’t have 20 months experience as a governor of a backwater state or she could come out of the closet and actually launch her presidential bid officially.

Anyway, back to the real plot. The author/journalist follows 4 young college grads through a year of school at a very bad high school in Los Angeles. People are getting shot, urinating, fighting, cursing, etc. There is no shortage of drama. You’d have to be crazy to want to teach in an environment like that. So I thought; then I saw an article on a California charter school program that structures itself like the TFA program. They take non-credentialed outsiders and put them in under performing California schools. The short, intense training program is similar to the TFA program. Since it was free to apply, I filled out their application and shot them off a resume. I wanted to teach high school math (Allen Greenspan said there was a shortage). I got an interview, but was cut after the first round (lucky for me!). After reading this book, I figured out why I was rejected. There are 2 personality types. Type 1: “internalized” every reason a child doesn’t learn is the teacher’s fault, Type 2: “externalized” there are too many external factors that are out of the teachers control, it’s not only the teachers’ fault. At the interview they asked me how I would react in a difficult classroom situation where a student simply could not comprehend what I was teaching. After answering “try again” and “try another approach” I dropped the ole’ phrase, “you can lead a horse to water…” BZZZZ. That’s the wrong answer. The TFA answer would be, “Lead the horse to water. If the horse doesn’t want to go, force him to go. Get some water down that horse’s throat. Pry his mouth open. Stick a hose in it. No matter what it takes don’t give up. Keep trying until you drown.”

Unions get a bad rap in this book. My cousin is a principal at a school in Texas and he hints at a similar problem. He cannot get rid of bad teachers (He moves them out of the students’ way.  His advice to me about educating my daughter is simply to get in touch with the principal. Lobby hard to get your kid assigned to the good teachers). In the end, the school board closes down an under performing school. This is the only way they can get a bunch of bad teachers out. It happens to be the same tool that the airlines use to get out of their union contracts. Shortly after they’re closed, a new staff and a new name take to the same walls … and the school is back in business. Then the process repeats. Bad teachers make it into the school and don’t get removed until the problem is so bad the school board has to “purge” the whole school.

This book was full of interesting little tidbits and historical anecdotes relating to the evolution of today’s electrical grid; most of which was annoyingly juxtaposed to the work of Henry David Thoreau. Electrical concepts are poetically compared to everything from the Senate terms to ocean tides.

The author contends that Thomas Insull was the 4^th most influential man in the early growth of the grid. Insull wasn’t a scientist but a business man who grew and consolidated the grid in Chicago at a much faster rate than any other major city, i.e. “Grid management innovations on a large scale.” He came from nothing. He worked extremely hard. He proved to the world he was a genius. He became a hero. He ended up an international fugitive. Quite a story for an important historical character I’d never heard of.

Technological innovation is nothing new:

“Those who suppose the intensity of technological change during their lives will never be equaled are probably wrong. Compare the 1990s with the 1890s. Consider, for example the 1990s’ electro-tech innovations having a large worldwide impact: ever more compact personal computers, wireless communications, email, the Internet, and optically read compact discs for music and video storage. An impressive list. But look at the multiple inaugurations of 10 decades before: radio signaling, diesel engines, motion picture cameras, x-rays, AC induction motors, radioactivity, and automatic telephone switchboards. One could probably locate many decades when the comparative change in technological life was just as noticeable.”

The internet and the electrical grid had many things in common. Lenin wanted a light bulb in every village and I remember Gates wanted a pc in every home. He pointed out that efficiencies gained in electricity generation petered out in the 70s, at the same time as the oil shock. This spurred a decade long positive change in consumption & efficiency (mainly in automobiles). Following that, we learn the concept of a “greener grid” is nothing new. Amory Lovins published the same ideas that are spreading now back in the 70s. It wasn’t popular with the industry. His ideas were only published in a foreign affairs magazine as a potential solution to mideast issues.

The author explores the idea that it might cost more to transport the electricity than it does to generate it. I can clearly see that given the high cost of copper and the low cost of generating capacity (the cost effectiveness of an off-grid solar system is directly related to your distance from the grid). He makes the case for decentralized micro-grids (hello sunny island) in the context of a poetic comparison of plant photosynthesis to photovoltaic cells.

Some books really shouldn’t be written so poetically.

Here’s what I find attractive about it:

- 3 years of investor exhaustion. In 2004, the market price was over $130 after adjusting for the reverse split. Everybody who has been involved in the stock for the last few years has lost money. This is usually when you get the most indiscriminate selling. I like buying from these types of sellers.

- The high margin core business has stopped bleeding cash. It is now cash flow neutral…but I don’t know for how long or how stable this condition is. No promises from management, either.

- Questionable (or no) analyst coverage. Yahoo has 1 analyst with a $30 target. Can’t find any reports on them with my limited resources. When I called the company they snubbed me and said “we’re not talking to the street.” That’s good. Wall Street hates companies that won’t talk to them.

- They’re about to be delisted from Nasdaq because the market cap of the free floating shares doesn’t meet requirements. If you’re an investor who purchased this anytime over the last few years and you’re down 50-95% on your investment and you get a notice saying nasdaq is going to delist, what will your reaction be? Answer: you’re going to dump it for whatever you can get for it. I like buying from people like that. Nobody wants to buy a stock that’s about to be delisted. I’ll buy it if it checks out.

- Investment bank Allen & Co. took a warrant with a $6.20 exercise price as partial compensation for exploring strategic options (i.e. selling the biz). That’s a good double above the current share price. Allen & Co is a hot boutique i-bank specializing in media and entertainment industry stocks. That is bullish they think they can get that much for it.

- Bill Gates, the 2^nd richest man in the world, has access to lots of fancy online data & statistics. His hedge fund owns it. You’d like to think that he knows what it is worth.

- Management was replaced at the end of 2007. I get the feeling that new management isn’t in it for the long haul. I dare say a “transition team?” The CFO and Tech guy have one year contracts. The CEO was previously a board member.

- Valuation: Trades at about 60% of book value. Much of the book value is cash. There is no debt.

- Replacement value: If I wanted to build from scratch an online community with $20 million in revenue it would likely cost at least 3x more than Planetout costs. This checks out; Planetout has spent about 3x their market cap over the last few years in capex developing their web business.

- Earnings potential. Planetout earned $1.50 per share in 2005, the only year it turned in positive earnings. Revenue was lower in 2005 than it was in 2007?!?

- They are the 9^th ranked dating/personals service on the internet according to some industry watchers. This is not the 9^th ranked gay site, it’s the 9^th ranked dating site for all types of people, gay, straight, tall, fat, etc I can see how internet dating might really be here to stay and I also see how it is a good, sticky business with lots of repeat customers. Large, reputable and specialized dating sites might indeed have a compelling value proposition for end users.

REPLACEMENT VALUE

I talked to some friends who are in the low budget, mom & pop web business and came up with a business plan to build a website that generates $20 million in ad revenues and subscriptions.

Here’s my plan: I’d go to moniker.com and buy a few “easy to remember” and obvious domain names. That would cost me about $500k to $1 million for some really good ones. This sounds silly but having “gay.com” might be one of planetout’s best assets! Obvious domains get traffic.

Next, I’d rent office space and hire a bunch of writers, photographers, web developers, programmers, ad sales, story editors, etc. Say 50 people or so… the average salary would be $60k including benefits. I figure I’d need to commit to 3 years. That would cost me $9 million.

I’d have to rent a good slug of office space in a fancy neighborhood. That would cost me $1.5 million for 3 years.

I need to buy everybody a computer. I’d need a lot of big computers to make up a “server” and I’d have to buy coffee machines, faxes, desks, chairs, toilet paper and various other office things. Hello Ikea? Hello Dell? That would cost me $500k because I’m cheap.

I’d need an ad campaign to tell people about my new site. I’d have to put ads on late night cable television, radio stations, other websites, etc. I’m guessing that would cost anywhere from $1 million to $10 million. Let’s use $5 million.

After spending all that (it comes out to around $17 million) and patiently waiting 3 years while the website gets built and the marketing machine gets the message out… I still might not get my $20 million in annual revenue. I could, however, just buy planetout.com for $10 million (which is what you are doing if you buy the stock at $2.60) If I could recover 50% of the excess working capital that is on their balance sheet right now, then that would bring my purchase price down to $5 million.

If Planetout can survive long enough, somebody, somewhere, somehow might want to own a bunch of websites targeting a wealthy demographic. This is arguably the leader and it’s cheaper to buy them than to develop your own. It seems like if the business is managed right it could be a sticky audience, like a regional newspaper. Warren Buffett and Charlie Munger made a ton of money buying regional newspapers.

Here’s what I do NOT like, and here’s why I’m passing on this idea (for now):

(1) Management is not eating their own cooking. No insider buys whatsoever. The CEO is getting paid about $1 million over the next year, that’s 1/10 the market cap. That is too greedy. Overall, the incentive packages looks extremely lame as far as alignment with owners. Pay her $1 million if she turns a profit. The CFO’s bonus is just for “staying on” an entire year. How about some humility folks? Your company destroyed $400 million in shareholder wealth over the last few years.

(2) It appears they have a bizarre, non-shareholder friendly corporate culture as if they were still some big-time dotcom star. Hello? Your market cap is $10 million. You’ve proven to the world you suck beans at allocating capital. Why not call a potential shareholder back when they call you? When I finally got through to the CFO he mentioned their burn rate. I do not like hearing about how they’re burning up capital. When a biotech talks about burn rate they better end the sentence with the market potential for whatever they’re burning capital to develop!

(3) The special situation hedge fund that is selling looks like they just want out yet no one will buy their shares and they’re not stupid enough to keep selling this far below book value. I believe this will cause what I have heard is called “overhang?” They’ve sold maybe 100k shares and still have another 400k or so left. They have a fairly diverse portfolio of small cap nasdaq stocks so I don’t think they’re suffering from any kind of margin or liquidity squeeze based on their holdings… but who really knows?

(4) No room for mid-sized companies. How can a mid-sized company compete in this space? You have easy entry into the business on a small scale from regional mom & pop or specialty boutique dating services. There is even off-the-shelf software for running a dating site that I can purchase for $1000. On the large scale, you have dominant mega cap companies (like yahoo and aol) that are doing huge dating sites with international reach. I can see how a consumer would want small or large, but why would they be attracted to a mid-sized company? Ok, this is a lame reason for not liking it.

In conclusion, I will pass for now but keep this on the back burner. I like the balance sheet. I know that buying companies trading at this much of a discount to book value generally works out ok. The CFO verified that the cash from the recent divesture, even though it was earmarked as future revenue, will show up as cash and will have no restrictions. If insiders pick up shares or I find out a more compelling reason to step up to the plate then I may change my mind. In the process of looking at Planetout, I came across Spark Networks which I may examine a little closer. It was written up on VIC not too long ago and is still priced cheap. If anybody has any comments or ideas about how to look at this stock or this industry then I would appreciate it!

One common theme I come across when reading about great investors is an extreme distrust of Wall Street. Wall Street is not your friend. The business of Wall Street is building up excitement and selling. To be successful, an investor has to resist the urge to buy what they are selling. Here is a paragraph Munger wrote from Wesco’s 1989 annual report that is timely today:

“As we select mortgage-backed securities, we will probably not be buying any complex instruments. Despite our love of comedy, we are going to avoid the newest form of ‘Jump Z tranches in REMICS.’ This refers to a particular contractual fraction – the ‘Z Form’- of a pool of mortgages, now subdivided by obliging issuers, advised by obliging investment bankers, into two new contractual fractions: (1) the ‘sticky Jump Z’ and (2) the ‘non-sticky Jump Z.’ At this rate, subdivision will soon get down to quarks. We are deterred from buying such securities partly by our hatred of complexity. We also dread the prospect of state and federal examiners, none of whom has a PhD in physics, reviewing, one after the other, our choices of soundness and billing us on a cost-plus basis without us as we yearn for a lost age when most reasonable people could, with effort, understand what was going on.”

As I read what happened in the late 80’s under Bush, Sr., I’m amazed at how similar our current real estate & debt market problems appear to be. Munger believed that the 80’s S&L crisis was due to poor regulatory oversight. Many blame the current mess on poor regulatory oversight. What a coincidence? Possibly poor regulatory oversight runs in the Bush family (Sorry, this is not a political blog; I dislike both political parties equally. Buffett and Munger come from opposite political parties yet still share similar beliefs regarding the lack of regulatory oversight).

I got the biggest chuckle out of a nickname that Munger had been given, “The Abominable No Man.” The idea behind the name is that very few investments are worthy so he ended up saying no frequently. Once an idea made it into the ole’ portfolio he was quite the optimist. In summary, this was an inspiring read. If you can’t find the book or make the time, at least catch this video.

If I didn’t already have a great car, I’d take that $66k and buy one of these wacky Aptera electric cars. The Aptera looks like a jet that’s had it’s wings clipped off. It’s built locally here in Southern California and it happens to get pretty good gas mileage. The MSRP is less than half the Lexus so with the leftover money I’d buy enough PV from affordable-solar.com to wipe out both my entire monthly electric bill at home AND my auto’s fuel bill… and that’s wipe them out forever (or at least until the 25 year warranty runs out on the panels). That is quite a value proposition.

Let’s see…

$66k on a clown-car shaped Lexus plus $4000 per year at the pump…

OR

$66k on a jet-shaped electric car PLUS free electricity at home for the next 25 years?

With the Aptera, I’ll never have to stop and get a fill up of gasoline again. I’ll plug it in at night and forget about it. The net present value of my gasoline savings will be enormous ($18k over just the next 5 years). If I can make the Aptera car last 9 years then it will pay for itself entirely from just the savings in gasoline. I wonder what the Lexus will be worth 9 years from now?

I looked at annual returns for the EAFE index from the year 1970 through the year 2007. It has averaged 11% per year. Year-to-date, EFA is already down a little over 18% including dividends. Year-to-date, 2008 has been a very bad year for EFA. Since 1970, only 4 times has it booked an annual return lower than 18%. The most it’s ever gone down in a single year was 26% in 1974.

Hmmmm… great risk/reward! It’s already down nearly as much as it ever goes down!

Then I looked more carefully and one of those down years is followed by another big down year (2001 and 2002). I don’t like buying some random index of mega cap foreign companies and watching the share price go down. I figure I’ll have to pay around $50 for EFA to get a price where statistically I am unlikely to lose money very soon after my purchase. Right now it is $63. Fat chance I’ll ever get the opportunity (but note to self: wake up next year and tap the ole’ margin account if it gets to $50ish). End of story for EFA.  I almost succumbed to gambler’s fallacy.

Wait. Not end of story. My internet connection went down today so I was forced to poke at those historical return statistics a little bit longer. Historically speaking, had I bought EFA in any one of those 4 really bad years that it was down more than 18% (like it is now) my average annual returns for the following 3, 4, 5, 6, 7, 8, 9 and 10 year periods would have been excellent. Unfortunately, there’s still a chance that the next year will be negative. But, there is zero chance that if I wait 3 years that it will be negative (if history follows… big if).

The next thing that popped into my mind was “why not just wait?” The answer is because waiting could be very expensive. Statistically, using the data provided, I should buy some now, not wait.

The 4 year average return following a big down year (like we’re having now) is a whopping 18% per year. That is outstanding! That is significantly higher than the overall average of 11% per year since 1970. Contrast those 18% average annual returns to the returns I would’ve gotten on EFA had I bought the index after an “above average” year… the average annual return over a 4 year period following a year where it booked an above average gain… *drumroll* is only 9%.

In a nutshell:

If you buy after it’s been doing great (“ooh, that feels good”) = 9% return*

Buy after it’s been doing bad (“oh no, I’m scared”) = 18% return*

*average annual return for following 4 years.

(There’s a lesson to be learned in there somewhere about chasing returns, piling on, buying high, etc.)

Ok, so what if I would have waited another year? There’s a good chance that I could preserve some capital. Let’s torture some more statistics…

Scenario #1 (75% chance of occurring) Assuming that I waited another year and the share price didn’t fall, then I would capture a cash return (3% per year?) for sitting on the sidelines. That’s no good.

Scenario #2 (25% chance of occurring) Now, if waiting turned out to be the RIGHT thing to do, i.e. this is one of those rare times that EFA has 2 down years in a row, then I would have preserved some capital (in 2002 it dropped another 18% after a 25% drop in 2001). In that instance, I would have preserved a 25% loss and booked a 3% gain on my money on the sidelines. Preserving capital feels REALLY good in case you haven’t tried it. But let’s look at what my combined average return would have been for 4 years so I can compare it with the average I got above. For the following 3 years, I would have averaged 21%. My overall average return for those 4 years would be 17% (1% lower than the 18% average I derived above). It looks like I should just buy some now. If it goes lower then wake me up next year and remind me that the following 3 years will likely come in really high.

Here comes the bear argument for why one should NOT buy EFA right now:

- They hold 25% financial stocks according to Yahoo. Some people think financials are cheap. I disagree. If even the CEO and/or an auditor can’t figure out the book value then nobody should be calling them cheap. All I know for sure is that financials have gone down a lot. The smartest people on the planet can’t figure out how bad certain long life assets will deteriorate given the massive lending fraud that occurred in the U.S. (and whose debt these foreign financial companies gobbled up in ways they’re not even sure about).

- Strong dollar predictions – Again, some people think the dollar will get strong. I think they’re thinking is irrelevant for 2 reasons (1) equities & currency aren’t really correlated. If you look at the index vs. the dollar there are many years where they move with each other, and many years where they move against each other. (2) Even if they magically become correlated, who really knows if the dollar will go up? If it does goes up it will have positive effects on foreign companies, too. Currency bets are kind of silly unless you have a real use for the currency. Currency only earns a “cash” rate of return.

- Sample Size – is the 37 year time period I chose a good indicator of future returns? A lot of crazy stuff happened over that 37 year time period. Remember Jimmy Carter? 37 isn’t a large sample size and history doesn’t always repeat itself. EFA could have peaked for good in October of 2007 at $86.50 per iShare!  I am probably using historical returns in a way that there not supposed to be used.

- Indexes change – I have no idea how this index changed over the last 37 years. Maybe 37 years ago it was full of textile manufacturers and wineries.

Fundamentals? What? Huh?

The iShares website says the EFA iShare tracks 816 stocks. I typed in the largest 50 ADRs into my AAII stock database. A few of them didn’t have a U.S. symbol and some of the data is probably off but the info is good for rough measure.

The results look good!

The average trailing P/E of the largest 50 securities, making up 50% of the index, is 14.8x. The 7 year running average P/E of these same securities is ~20x.

The average P/E using analysts’ estimates for 2008 comes out to be 11.8x earnings.

The average P/CF is 9.8x. The 7 year average is 14.6x. The average yield is a hair over 4%.

This book ties in with the Eater’s Manifesto book that I read recently. The Eater’s Manifesto says that if us Americans moved down the food chain we’d be healthier, happier, and skinnier. We’d live longer, too. Moving down the food chain means eating more plants, less grain and even less meat (meat is essentially concentrated grain). Outgrowing the Earth takes another approach and says that if we move down the food chain then a positive effect will be felt for the 60% or more of the world’s population that is living on subsistence level diets. It’s a win/win situation. We live longer – they get to live. There are many environmental positives, too.

I’ve worried about the Chinese & the Japanese owning so much of our treasury debt. I never understood why they bought so much. I knew they did it to keep their currency down but I completely missed the food & security angle. Putting our massive debtload in context; as of 2004, the debt the Chinese held would buy our entire grain crop for 2 seasons. Prices of grain have gone up since then at a faster pace than our national debt (probably the only thing).

]]> http://coherentcommentary.wordpress.com/2008/08/28/outgrowing-the-earth-by-lester-r-brown/feed/ 0 chris http://coherentcommentary.wordpress.com/2008/08/08/natural-gas-and-electric-power-in-nontechnical-language-by-ann-chambers/ http://coherentcommentary.wordpress.com/2008/08/08/natural-gas-and-electric-power-in-nontechnical-language-by-ann-chambers/#comments Fri, 08 Aug 2008 19:02:35 +0000 chris http://coherentcommentary.wordpress.com/?p=13 ]]> This book was published in 1999. At that time, natural gas was $2.75/mcf. With the help of industry data and the brightest minds of the time, the author made the astute projection that by the year 2020, natural gas would likely cost $3.30/mcf.

Despite this unfortunate gas prediction, and the fact that it reads like it was sponsored by the natural gas industry, I liked this book. If you are an energy investor, I would recommend you borrow it from your library. I studied upstream energy E&Ps and I have studied home-retrofitted solar systems (as downstream as you can get). This book fills some gaps with it’s coverage of transmission, generation, politics, and history. Here are some thoughts that came into my mind as I read:

(1) The life of the grid as we know it is less than 100 years old. Solar panels offer the consumer a 25-30 year value proposition, yet the entire home-delivered grid is, in the grand scheme of things, quite new. Things have changed dramatically in these 100 years. Stranded costs are huge part of the evolution of the electric grid. A 30 year commitment could look very smart, or very stupid.

(2) Despite what we’ve seen in recent years, deflation has actually occurred for decades at a time. Coal prices steadily trended down despite higher consumption from the early 80′s through the late 90′s. Electricity had similar decade long downward pricing trends thanks to efficiency & technology.

(3) This 9 year old book is a fine testament to the saying “expect the unexpected!” This book talked extensively and positively about convergence, which quickly became a dirty word after Enron.

(4) The book points out that a lot of generating capacity is retiring over the next decade. It makes the case that natural gas will be a shoe-in as a replacement. I’m left thinking that a Picken’s type plan might not be that crazy despite the incredible amount of capital required.

(5) The enormous amounts of capital spent in the past for various forms of generating capacity and transmission lines bias future decisions. Again, back to the pain of stranded costs. A real, non-political, long term energy policy is what this country needs. Maybe we even need a non-political body to set energy policy on an ongoing basis. Capital investments need to be made while thinking about 20+ year terms, not 4 year political terms or quarterly 10q reports.

It quoted new construction costs for a natural gas plant at around $.50 per watt, which isn’t far off from a recent government report on new power plant costs. I was excited about the information in the government report until I found the previous years government report by the same title. For the most part, all the prices are just an even 10% higher. What the heck kind of analysis results in a flat 10% across the board increase for a variety of drastically different capital investments?

I’ve been reading a few research reports on utility companies. I did a brief analysis of a utility etf that I’ve owned since the Enron days, XLU. I approached it from a replacement cost point-of-view. I used that government report and bits of generating data I could get from each of the companies’ 10k’s. When you buy XLU for $38 you are basically buying generating capacity for $1.71/watt. That’s the index weighted average TEV/Watt per $ invested in XLU so it includes debt and doesn’t include transmission (a significant asset) or intangibles. Some of the utes didn’t have generating capacity which brings the cost up some. On a weighted average basis, the generating capacity works out to be about 27% nuke, 34% coal, 25% gas and the rest is other stuff like hydro, oil, wind. Compare this XLU investmet to paying an expensive Santa Monica solar panel installation company to put panels on your roof, you might pay $7/watt after rebate & credits. If you’re clever you can do it yourself for $3-$5 (after rebate). Then again, you might be better off buying XLU and avoiding the electrical shock.

This book, In Defense of Food, touched on a worry that’s always been in the back of my mind: there could be a consumer backlash against the basic consumer staple that fills the middle part of a basic U.S. grocery store. You know, the bread, chips, cereals, sodas, frozen dinners, prepared foods, rice-a-roni, etc. According to this book, the stuff in the middle of the grocery store isn’t food and shouldn’t be eaten. If you must go into a grocery store, stick to the stuff your great grandmother would still recognize. They put all the good stuff, real food, on the edges of the store… dairy, fruit, meat, etc. Am I really worried about the backlash? Hmmm… have you seen Whole Foods stock? It is tanking. I guess that consumer backlash is not such a huge worry.

On a personal note, I do about 40% of the grocery shopping for my family. Even before this book came out I noticed that there was nothing for me in the “middle” of the grocery store. I can cook a great meal for $10-$15 if I buy just the raw ingredients (meat, vegetables, wine). The basic consumer staple company takes a bunch of raw ingredients that are cheap, combines them in a way to make them taste good, last a long time and be attractive on the shelf. It then markets them with fancy advertisements to the people who are the most susceptible. Nutritionists, chemists and chefs working for the consumer staples company are experts at teasing out what the consumer wants, not what the consumer needs, thus the U.S. population is increasingly overweight and malnourished (a paradox). Symptoms of malnutrition are showing up in overweight teenagers. This book argues that modern nutrition’s approach is flawed (de-constructing nutrients). The book uses a clever combination of data and anecdotes to make the case.

The author is obviously a very intelligent writer and this book was a joy to read. Ok, I’m just an idiot blogger but I’ll take a quick stab at the other side of his anti-establishment argument:

1. Consumer staple companies have added value. Among other things, ginger ale is a friggin’ great invention. My next door neighbor in Texas, a doctor, used to recommend we eat soda crackers and drink ginger ale when we had an upset stomach. It worked. Thank you Schepps and Nabisco.

2. Scientist are questioners. In order for them to perpetuate their “de-constructioning” nutrients methodology, there must be good data and/or history that validates it. This book mined data that supports the opposite (i.e. eat real food, not too much, mostly plants) from weak and indirect (albeit colorful and intuitive) sources. I don’t care how much you pay a scientist to keep them quiet, eventually the truth will come out.

3. Maybe if the French were malnourished Paris would be a friendlier place?

I bought some 10 year TIP bonds in my tax deferred account. My timing isn’t ideal on this and I’m not particularly excited about this idea but, in the context of all the alternatives, I like the risk/reward scenarios of the particular 10 year TIP that I bought (cusip # 912828JE1):

Hold-to-Maturity
10 yr TIP Return Matrix
CPI-U inflation	nominal annual return
-5%	1.40%
-4%	1.45%
-3%	1.50%
-2%	1.55%
-1%	1.60%
0%	1.66%
1%	2.28%
2%	3.19%
3%	4.09%
4%	4.99%
5%	5.89%
6%	6.79%

CPI-U is running 5% for the year right now.

CPI-U is running a little over 4% year-to-date.

Over the last 5 years, in a “low inflation environment” CPI-U still came in at 3%

During the oil shocks of the 1970’s, CPI-U was over 8%

One more comment on this funny looking matrix. How come the bond costs 96, pays 100 at maturity and 1.375 coupon yet it still has a return only ~100 bp above inflation? The answer is that my returns above are probably too low because of both the timing and the way I handled the reinvestment of the coupon. Theoretically, you should just be able to add the coupon to inflation and get pretty near to what your nominal return would be. In other words, 1.375% coupon + 4% inflation gives you closer to 5.375% annual return, not 4.99% as my matrix does.

I got these lower numbers because I crudely put together what was like a DCF evaluation. The return I got above is the actual discount rate that brings you back to the price you paid for the bond. I wanted to use a discount rate to determine the return so that I could see effects of deflation on some of the bonds that have already been marked up to reflect past inflation. With these bonds, if there is deflation you will lose money if you hold to maturity, as the government only has to give you back the face value. Also, a TIP etf (like the ishare) holds many bonds that have been marked to reflect past inflation. That is a small negative to consider (as I can’t imagine deflation in this crazy environment), but after all, you really expect at least decent performance out of treasury bonds in deflationary environments. You’ll lose money if you buy ones that have already been adjusted up if we have deflation.

I’m a saver first, and an investor second.

The reason I invest is to get the most out of my savings so the two terms, saving & investing, often get mixed together. This TIP idea is not an investment, but a method of saving (bordering on speculation). Further, I cannot invest all my capital. I don’t have the stomach for it. I don’t need to do it. I rarely have the conviction to put that much to work and I rarely find the opportunity. If I find such an opportunity that I need additional capital, it should be easy to liquidate these TIP bonds and, in that case, I’ll likely have such conviction in the idea that I’ll gladly risk selling at a bad time. Meanwhile, it is a good place to “save” purchasing power despite the deceptively low appearance of the 1.375% coupon.

So I can’t invest my capital, what else can I do with it? (I’m always open to ideas):

Cash pays 2%

Muni reset bonds pay me 3 or 4% tax free (I’m loaded on these, and they’re drying up)

Fixed rated treasuries and investment grade bonds yield between 3 and 6%.

Buying some TIP bonds with that sideline cash seems good. I have a favorable taste in my mouth from past inflation related securities. From 2000-2003 I bought U.S. government iBonds directly from the treasury. I have a stack of them in my closet. I can cash them at the local bank any time I want. In truth, I bought them because (1) they yielded more than cash and CDs yet I could cash them after a very short holding time, and (2) the gimmick: I could buy them with a cashback/rewards credit card. I got an immediate discount to the purchase price because of this. Some of them are yielding 8% now, tax deferred. When I send my daughter to college I will be able to cash them and the gains will be excluded from the taxes altogether (if I’m in the right bracket or the tax laws don’t change dramatically). The jig is up on buying more of those. No more credit cards and a puny $5k limit is set now. The real returns are set at zero! Stay away for now but keep an eye out in case they return someday.

CPI-U issues:

CPI-U is the driver for this investment. CPI-U hasn’t stayed up with real world asset prices because it’s not designed to track asset prices. Bill Gross complains that it’s manipulated and deflated. It sure seams so. Theoretically, included in the price of a loaf of bread are the hard asset costs for the bakery, the land the bakery is on, the steel, etc.  As time passes, those higher costs will get passed down to the price of the loaf (if the miracle of productivity doesn’t get in the way). These prices get passed down slowly. They don’t need to buy a bread factory every day.

CPI-U and personal disconnections: I live in my own unique inflationary/deflationary environment which I work hard to control. I shouldn’t confuse that world with the broad CPI-U. For example, the price of housing is falling dramatically for my family (we’re house shopping now), yet housing costs as measured by CPI-U are going up, the exact opposite direction. Housing is a big part of CPI-U but it’s measured in a strange way. Over time, it will reflect the real housing costs. It’s got some catching up to do in that department.

Perceptive people do things to avoid future expenses. I’m a perceptive person. I’m already thinking about ways to get my 3 year old daughter a scholarship. When I install a PV system on our new house, I will benefit from higher electric costs, not suffer as one would expect if your expenses were tied to CPI-U. That’s what buying a Prius or installing a gray water system is all about. As my grandmother taught me, it’s not what you earn that’s important, it’s what you save. So look into the future. Make your assets go higher and make your liabilities lower.

Armchair Economist…Likely scenarios/outcomes:

LOW INFLATION:

Investment will underperform cash by a tiny bit. I probably would have had cash on the sideline anyway. In low inflation, low interest rate environments I would be able to borrow extra cash for short term investments without any problem.

MEDIUM INFLATION:

If inflation is in the medium range, this investment will outperform cash and bonds.

HIGH INFLATION:

This investment should do extremely well if the perception of future inflation goes from it’s current place (3-4%) to any higher, more realistic place (4+%)

Depression/Recession/Deflation:

This still produces a real return and still has duration & top credit quality, thus it should be a safe haven.

Higher “Real Returns” on Bonds:

If we go back to the days where investors get compensated 3+% above inflation for holding treasury bonds then the market price of the bond will suffer. This is a problem. There is no guaranteed way to get my principal back until maturity (10 years).

The biggest selling point for buying TIP bonds is looking at historical inflation:

Year	cpi-u
1970	5.12%
1971	3.36%
1972	3.41%
1973	8.80%
1974	12.20%
1975	7.01%
1976	4.81%
1977	6.77%
1978	9.03%
1979	13.31%
1980	12.40%
1981	8.94%
1982	3.87%
1983	3.80%
1984	3.95%
1985	3.77%
1986	1.13%
1987	4.41%
1988	4.40%
1989	4.63%
1990	6.17%
1991	3.02%
1992	2.95%
1993	2.73%
1994	2.66%
1995	2.56%
1996	3.28%
1997	1.73%
1998	1.61%
1999	2.67%
2000	3.37%
2001	1.55%
2002	2.40%
2003	1.88%
2004	3.26%
2005	3.39%
2006	2.56%
2007	4.08%

How many years did we have deflation? ZERO

How many years did we have inflation lower than 2%? FIVE

Here’s what you earned on your cash in highly inflationary time of the 1970’s.

Had you bought this exact bond in 1970 and held it for the decade, you would have earned 9.21% nominal return vs. 6.67% for cash.

TIP bonds and Modern Portfolio Theory:

I did something kind of crazy here. I took historical inflation, added the coupon I got on the 10 year tip, and threw all those returns into a mean variance optimizer with long bonds, cash, the S&P500 and even EAFE index. This is crazy (alright, it’s just wrong) because I’m assuming that these returns are actual returns an investor would see, when in reality, the price of the tip bond would be all over the place. This would only be a valid comparison if I could buy and roll over 1 year tip bonds, not 10 year tip bonds with some duration. The result: In a portfolio with a targeted expected return of 8%, you have .5% less volatility if you include tips instead of cash.