Monday, March 31, 2014

Macworld 2014 Rounds Up Apple Fans And Tech Stars

My first computer was an Apple Macintosh I bought in 1995.  I kept it for as long as I could until I had to switch to a Windows laptop in 2000.  I rarely revisit Macintosh tech unless some high-profile event entices me.  Enter Alfidi Capital into Macworld / iWorld 2014 at Moscone North last week in San Francisco.  I had to go to see if I could score free food at the afterparties.  Seriously, I went to see cutting-edge tech.

My free expo pass didn't get me into any of the supercharged intellectual conference sessions.  Sooner or later the people running high-profile conferences are bound to recognize my extreme genius and put me on their speaking calendars.  I shall prowl their expo floors and free sessions until those salad days arrive.  The coolest thing I saw on this year's expo floor was the FLIR ONE infrared attachment for the iPhone.  I asked the booth dude to take my picture with it, and the result is below.

I must admit that I look quite handsome even when I'm only visible on the infrared part of the spectrum.  Women can't resist an infrared version of Yours Truly.  I look like the enlightened Buddha or something similarly transformational.  I first noticed FLIR ONE in some news report from the last CES in Las Vegas.  I'm impressed that FLIR is branching out from the defense market.  Now everyone can take infrared pics of their household pets and post them to Instagram.  They'll all look the same and no one will care because yokels love novelties.  The product may actually have some commercial uses besides physical security.

The "makers" on one of the free stages discovered some things that got me thinking about how quickly a manufacturing renaissance can happen.  Form factors matter so much that third party accessory makers must have good OEM specs so their components properly fit those major items.  The best synergies for smartphones, AI, and robots right now will come from routine tasks managed remotely (think Roomba).  Ordering but not shipping keeps customers in limbo, but some makers think they can get away with such poor service.  If it happens deliberately, consumers have a case for the Federal Trade Commission to investigate.  Good companies constantly model demand versus their capacity, and plan expansion to meet demand.

The live Vector podcast from iMore was very much for hard core tech fans who think Wall Street tries to push Apple into doing bad things.  I'm no fan of Wall Street either.  Developers are passionate about Apple keeping its acquisition strategy focused on buying small companies that add to its tech base.  They would be aghast if Apple ever pulled a headline-grabbing stunt like Facebook and Google's typical billion-dollar acquisitions.  One panelist was skeptical about the total addressable market (TAM) for virtual reality (VR).  He may have a point some humans naturally resisting immersive environments due to phobias and the limits of physiology.  I think the TAM for VR will prove to be small but lucrative for niche players.  A whole nerd subculture has grown up around gaming and they spend serious coin on tech.

The Macworld interview with Dr. Jeffrey Smith, CEO and founder of Smule, turned out to be a huge eye-opener.  He figured out how to make apps that mimic piano chords and wind instrument effects.  His most important discovery is the value of music as a shared activity.  People are very happy to collaborate on musical performances over long distances.  Smule apps make money when people share their music online.  I first noticed the power of online musical collaboration when I saw a YouTube clip of Eric Whitacre's Virtual Choir singing "Sleep" a couple of years ago  The choir shares Smule's philosophy of democratizing musical performance.  Latency constraints degrade long-distance live performances but they are no problem in recorded performances.  Dr. Smith's description of digital archives that collect millions of recorded music performances gave me a brainstorm.  I am convinced that Big Data sets of amateur musicians now present a disruptive opportunity in the music industry.  Data mining these performances for talent establishes a "Moneyball for music" set of baselines that can estimate a performer's marketability.  This disintermediation of music from recording studios and performers' unions is the ultimate free-market end run around the music industry's traditional gatekeepers.  You're going to hear more about this concept as I develop it in future blog posts.  Thank you, Dr. Jeff Smith.

Live podcasts proliferated at Macworld.  TechHive's Clockwise podcast discussed what home appliance Apple would make if it could.  I vote for a clock radio, since Apple already knows how to put timekeeping on the iPhone and music in an iPod.  Macworld's Pundit Showdown Live podcast featured the very attractive Susie Ochs of TechHive, who did cute dances in her chair whenever the host played some theme music.  The pundits need me on their next podcast because I offer more than nerd references to Ars Technica.  Tech I hate?  Bitcoin.  Myth I'd dispel?  The need for all of us to learn coding.  I got the vibe that the DECE consortium's UltraViolet digital library has a bad rap among Apple's fan base.

One panel of longtime Apple watchers debated the company's past, present and future.  I think early adopters would love Apple wearables based on these guys' chatter.  I grokked a consensus from several panels like this one that Apple doesn't pursue niche markets like gaming.  I can't understand why they would cede the huge gaming market to Microsoft and Sony.  Apple may be happy to grow its share of the desktop PC market by default as people turn away from Windows PCs and adopt tablets.  Mobile isn't going to completely destroy desktops no matter what tech gurus like to say.  Knowledge workers must still perform word processing and data analysis using the keyboard/mouse interface, so desktops and laptops have a future.

One of the last free sessions I could attend at Macworld 2014 was a Bitcoin Meetup.  Yeah, right, I know what you're thinking, I went there just to stir things up, right?  Well, I behaved myself except for the few loud snickers I uttered in the back of the room.  These Bitcoiners repeatedly contradicted themselves.  They claimed Bitcoin couldn't be destroyed by any government, but then said a few coders could change the algorithm to make it do something completely different.  I spoke with a few of them afterwards to test their intellectual abilities.  I told them that the IRS's recent ruling on Bitcoin meant that everyone who mined it since 2009 would have to file amended returns to report that mining as income.  The scofflaws among them claimed that wasn't necessary.  I then reminded them that the blockchain is publicly visible and FINCEN won't have much difficulty tracing Bitcoin owners through that chain so the IRS can gather a list of its tax evaders.  My logic opened the eyes of a few curious people in the room who had not drunk the crypto-hogwash.  These people were mostly schmucks disguised as coders.  One guy was pitching some open-source contraption that was supposed to be a Bitcoin ATM running Raspberry Pi.  It looked ridiculous.  Someone would have to be really stupid to stick their ATM card in something that looks like a toolbox.  These people are tools.  Stupid tools love Bitcoin.

I'll end on a high note.  I went back to the expo floor where one of the audio techs working the second stage's soundboard recognized me from other conferences.  I didn't recognize him but I take this as a sign my reputation in Silicon Valley is growing if even the show floor operators know me by sight.  He mentioned his desire to get involved in this whole startup scene himself.  I related the story of David Choe, an artist who painted murals on Facebook's corporate walls in exchange for shares.  His Facebook shares later proved to be worth a fortune.  You don't need to be a software engineer or financier to strike it rich in Silicon Valley.  The very first corporate treasurer, HR director, and night shift security supervisor at Yahoo, Google, and Facebook probably made out like bandits if they had stock options.  Anybody who shows up at enough Meetups, seminars, pitchfests, and conferences with their specialty in hand stands a chance of landing a gig at a VC-backed startup.  Bring your thing anywhere, even to Macworld 2014.  

Changing Low-Earner Behavior With Low-Information Incentives

A bunch of finance apps innovators shared their tips for changing behavior at last week's Meetup.  I attended because I'm always on the hunt for new control mechanisms that the ruling class can implement.  The open-source fin-tech community is always a big help.

One entrepreneur mentioned Startuponomics, a behavioral economics event that informs some of the business models percolating through fin-tech.  Irrational Labs puts on that show.  I don't pay to attend pricey events so they'd better invite me to speak.  Startups learn things like the importance of word choices in prompting debtors to honor their promises to pay, and this apparently drives improved debt repayment rates.

"Persuasive design" is a subset of persuasive technology that drives humans to make appropriate financial decisions.  It is the natural evolution of Edward Bernays' ad techniques into an all-encompassing environment for driving human behavior.  Action-oriented verbiage, emotionally warm color tones, and gamification that rewards prompt repayment with expanded borrowing limits are all persuasive tools.

I actually think it would be beneficial to use video and animation that talks down to low-information consumers.  Low-IQ people respond well to emotional appeals and celebrity endorsements in focus groups.  The imagery should be as condescending as possible to be effective.  Animated walk-through visual tours of a financial service encourage adoption because the vast majority of humans want to be told what to do in life.  Behavioral finance works well on stupid people.  The poor really should respond well to cartoon animal mascots telling them how to save, invest, and borrow.

A couple of the startups mentioned their reliance on electronic bill payments, and how vendors caught them off guard by accepting only paper checks.  Anyone who only deals in paper checks is way behind the times.  I pay as many bills as possible electronically.  Shame on those sloths who are unwilling to deposit checks in a timely manner.  Their poor cash management practices will be a death knell in a hyperinflationary economy.

My descriptions above reflect more than just a Jonathan Swift-like modest proposal to drive financial technology.  I truly believe that the lowest social classes want and need benevolent guidance from elites.  Fin-tech startups really do want to empower the poor to make better financial choices.  Bringing them inside the capitalist system from the fringes makes everyone better off.  Society becomes more stable, the poor become responsible customers, and the rich remain in power.  The best revolutions are the ones that leave elites entrenched while everyone else is better off.  Behavioral finance will change lives.

Nota bene:  I redacted one paragraph from this article on April 1, 2014.  I decided upon reflection that it was over the top and just plain unnecessary.  I go pretty far out there sometimes, but when I go too far I know when to pull back.  

Financial Sarcasm Roundup for 03/31/14

March is almost over and the "ides" passed without incident from either lions or lambs.  Calendar idioms aren't very useful in sarcasm.  Financial topics are a lot more useful.

The IPCC is raising the alarm about the climate change threat to the world economy.  I hope they put enough qualifications about probabilities in their report this time.  Critics need to read the footnotes carefully.  The bright side of climate change is that previously frozen tundra will make great farmland.  Just think of the lucrative eco-tourist opportunities that will be available when inland flooding turns previously inhabited floodplains into marshes.

US stock markets are rigged to favor HFT funds.  No kidding.  I've been saying that since like, what, 2008 or so right here on this blog.  Individual investors, traditional mutual funds, and even index funds are getting nickel-and-dimed to death by hedge funds that pay for special access to trade information.  Making new platforms to route around HFT won't matter for long.  HFTs will sign up for those platforms and start gaming them all over again.  The manipulation will persist until a market crash destroys hedge funds with margin calls and rising interest rates remove cheap leverage from those hedge funds that remain.

China wants to make life easier for foreign institutions in its QFII program.  The hidden agenda here is obvious.  China knows it can't bail out all of the shadow banking WMP instruments that are in danger of popping.  Making QFII participation more attractive allows foreign suckers to buy into these things before they collapse.  Let's see if foreign banks rush in fast enough to get sucked into a shadow bailout of the shadow banking system.

I'll be down in Silicon Valley this week seeking out technical wisdom.  Who knows what new innovations lurk there.  

Sunday, March 30, 2014

The Limerick of Finance for 03/30/14

Day traders are wasting their time
Charting random noise that does not rhyme
Put away all those sticks
Study deep value picks
Stock prices can turn on a dime

Box Dev 2014 Flew Drone Cam For Cloud Enterprise

Box held their first ever developer conference last week.  I dutifully attended Box Dev 2014 thanks to a hot ticket from Angel Launch.  My favorite people always hook me up with multiple blessings.  The free food was of course a major incentive.  Breakfast bagels, Off the Grid lunch trucks, and spicy dinner entrees were enough to get me excited about hanging with cloud enterprise developers.

I sat very near the front for the early talks and I checked out the folks at the so-called "media" tables.  They didn't look like they were banging out too many articles on the event or even taking notes.  That's why I take these events seriously.  Silicon Valley can always count on Alfidi Capital to pay attention when everyone else is falling down on the job.  Slackers checking email and Facebook can hang out somewhere besides the media table.

The CEO of Box is quite a charming fellow.  His cloudy socks and bright sneakers reminded me of Marc Benioff's fancy high-tops at Dreamforce 2013.  Cloud entrepreneurs have a thing for wild wardrobes.  Box is convinced that the addressable market for mobile information workers is larger than the market for people chained to a desktop.  They have tailored their cloud enterprise offerings accordingly.  I think Dropbox is an obvious competitor, but when I heard Dropbox's CEO discuss his company with Marc Benioff at Dreamforce 2013 I don't recall whether he spent a lot of time emphasizing mobile.  These two box-related companies are going to fight it out over enterprise sharing.

Entrepreneurs also have a thing for wild stunts.  Box's SVP for development came out to chat up their ability to connect the enterprise to all kinds of things.  Lo and behold, Skycatch flew a drone out to the strains of Darth Vader's theme music and took a digital image of the audience.  Drones now have an undeniable cool factor.  The drone is in the photo just above.  I was impressed that it could navigate the confined space of those curtains adjoining the stage without becoming unstable.  Photos come with metadata that Box aims to capture.  Image metadata has obvious uses in GIS for identifying frequent locations of system failures, sales calls, and other things that will drive enterprise revenue and costs.

Entrepreneurs can capture a few more lessons from Box's success than the implications of image metadata in GIS.  Sales is still the most important traction metric, but efforts to grow a startup's numbers of third party developers, API downloads, and SDK uses are worth doing if they drive some buzz.  Even page loads and white paper downloads generate metrics for startups desperate to hang their hat on something.  Cloud platform providers should also think about having more than one pricing model.  Pay per user (accommodates seat count changes), pay per time (accommodates seasonal surges), and pay per capacity (accommodates an expanding enterprise) all have their place somewhere.

The fireside chat with legendary tech star Ben Horowitz gifted the audience a free copy of his book The Hard Thing About Hard Things.  I have to love a show that gives me both free food and free books.  Ben liked Intel's approach to growing its market beyond memory.  I did not know that the "cloud" term came from Bell Labs' technical descriptions of telecom connections.  I thought some marketing pros dreamed it up.  Ben's favored technique for a package software company (read Microsoft) to turn itself into a cloud service company (read Salesforce) is to acquire a cloud startup and promote that startup's founder to CEO of the acquirer.  I don't know of any case where that succeeded, which is probably why Ben thinks such a transformation is so hard.  I was very disappointed to hear that Ben was bullish on Bitcoin.  His VC firm Andreessen Horowitz is making big bets on Bitcoin.  I'm pretty sure they're going to lose it all, but I won't guess about the timetable.

Palantir's founder got some stage time with one of the hottest female tech journalists I've ever seen.  War stories about PayPal are part of Silicon Valley's lore.  I was more intrigued by the guy's pro-market opposition to rent control and desire to unskew the asymmetrically high compensation in the finance sector.  This wasn't the first time I've heard entrepreneurs warn that large firms use regulatory capture to make business hard for startups.  I wish I could get as excited as him about AI and VR but those things have been five years away for the last twenty years.  The hype about AI and VR reminds me of the perpetual hype for nuclear fusion.  It keeps the research money spigot stuck in the on position with no commercial success stories.

The VC panel tried to make some five year predictions for mobile, VR, and other enterprise tech but I don't think they got any farther into probable successes than the Palantir guy.  They did make a worthwhile observation about how SaaS contracts favor short-duration pilot terms with cancellation options.  That goes back to my own thoughts above about having a diverse pricing model.  One client that cancels a short contract is welcome to consider a surge capacity contract.  These VCs claimed that some startup types cluster in certain cities.  That's true in niche sectors like agriculture, which is so far clustered in Northern California.  I've noticed that many mobile and social startups pop up in all the big cities.

I don't think these VCs have many blind spots.  They ought to see the disruption potential in capital-intensive verticals with long sales cycles.  Startups can capture that by breaking up SaaS sales packages into piecemeal iterations.  Salesforce did that with functional modules.  Go back to my pricing model notes above and figure out where to start.  The "grow fast" go-to-market strategy of consumer SaaS is not the same as the enterprise SaaS strategy of proving speed and agility in overcoming friction.  The panelist VCs know this and startups should know it before they design for one market at the exclusion of another.  The VCs measure the density of a SaaS solution's network connections by stickiness, virality, symmetry, and intraenterprise strength.  In plain English, that means enterprise SaaS is more likely succeed with very dense connections that encourage KM collaboration.  Know your monthly recurring revenue (MRR) and its churn before you pitch a VC, and don't pitch standing up when the VC asks for a sit-down conversation.  The venture investing community can be finicky.  I know they read my blog.

The CIO panel repeated a lot of things I've heard before at tech conferences.  Every IT leader wants to jump on the innovation bandwagon because running a cost center is a career dead end.  I did not know that the security landscape is evolving faster than the rest of the tech sector.  Maybe all of the warnings about app security are finally turning into action.  This poses good career opportunities for white hat hackers who can find and plug security holes.

Jerry Yang moderated the CEO panel.  The other CEOs on the panel sounded like they really grok CustDev.  They should get along well with the earlier CIOs who said they like startups that solve problems.  These CEOs admonished the crowd not to sell something they don't already have; apparently a lot of techies need to be told that only established companies can announce vaporware.  Their descriptions of reward systems that incentivize adherence to company values reminded me of things I've blogged before about corporate cultures.  Folks need to know that the CEO's personality and the HR compensation structure will determine everything.  That's Alfidi Capital wisdom.  I agree with the CEOs that their job is to tell employees they're doing a good job, and that no one will tell the CEO whether they're effective.  That is why KPIs tell CEOs whether they're succeeding.

I gave Jerry Yang a thumbs up as he walked out of the Fort Mason Pavilion after his panel.  He's the one on the left in the photo above.  I will always be grateful for his second stint running Yahoo because his resistance to Microsoft's buyout offer in 2008 opened a decent arbitrage opportunity for me.  I made some money on the differential between the two companies' short-duration options even though the merger deal wasn't consummated.  Thanks, Jerry.

The final fireside chat between legends Phil Libin and Steven Sinofsky was the stuff of legend.  Techie culture supposedly encourages internal teams to borrow each others' ideas during the SDLC, but I wonder how many companies practice what they preach.  Phil said in no uncertain terms that Evernote employees who make PowerPoint slides are unwelcome.  That is stunning, and awesome.  He correctly places slides in their sales role because he wants a higher cognitive model for engaging teamwork.  His vision for workflows that transition seamlessly between mobile and desktop is the kind of sea change forcing packaged software sellers to move their products to the cloud.  I do not agree with his prediction that the touchscreen interface will replace the keyboard/mouse setup simply because it's more comfortable for natural human hand movements.  Knowledge workers still need to input data somehow and touchpad reticles can't do the whole job.  Let me summarize this conversation's brilliant closer, driven by Facebook's acquisition of Oculus Rift:  "Oculus is something you put on your FACE.  It was bought by a company called FACE-book.  We'll see thing like Box-FACE in the future."  That had the audience rolling.  Great stuff.  You had to be there to see tech genius at work.

I have no idea what Box's platform does for clients.  They put on a really high-powered developer conference where I scored free food and wisdom.  Their CEO can mount a stage at a running leap, so maybe he ran track in high school.  They should hold a hackathon at their next conference to motivate developers to build Box stuff.  I'm impressed enough with everything to return next time.  

Saturday, March 29, 2014

The Haiku of Finance for 03/29/14

Adjusting swap price
Mark to market and disclose
Complicated math

Using And Misusing XVA Swap Pricing Adjustments

Welcome to the world of swap pricing.  I have never touched swaps in the real world.  Studying their construction during my MBA program was certainly intriguing.  Institutions using swaps in moderation can hedge their exposure to swings in interest rates, commodities, and currencies.  Pricing them realistically means adjusting for the possibility of counterparty defaults.  Adjustments used to be confined to credit valuation adjustments (CVAs) but now encompass a whole family of "XVA" alternatives.  Risk Magazine in 2013 recognized the key role that banks play in using XVAs to price derivatives.

Capital markets quants have choices to make among XVAs.  The original CVA and debit valuation adjustment (DVA) formulations were mirror images of each other.  They balanced a swap's accounting on the mark-to-market exposure statements of both swap counterparties.  Adding a cost adjustment to the DVA builds a funding valuation adjustment (FVA) that provides further clarity on how lending costs for an uncollateralized transaction affect swap exposures.  This very detailed Shearman and Sterling article describes how the legal treatment of these FVAs under Basel capital requirements may differ between US and EU regulatory regimes.

The FVA takes derivative game-playing to a whole new level.  The concept's creators explain it in this Risk Magazine article, "Funding strategies, funding costs."  I don't see the point in adding a second layer of complexity to an already complex process for adjusting derivative prices.  More complex systems are more fragile.  We learned that the hard way in 2008 when investment banks underestimated their own weaknesses.  Adding a replacement valuation adjustment (RVA) to the other layers makes things even more complex, although I can see the usefulness of using it as the only adjustment layer for swaps that have downgrade triggers.

FASB 159 allows corporations to use XVAs to adjust their financial statements.  This takes the debate over smoothing earnings to a whole new level of unreality.  Analysts need to look at MD&A footnotes more closely to see whether systemically important financial institutions (SIFIs) use XVAs to play games with their numbers.  CME Group has an excellent KPMG white paper on principles for managing CVAs.  It is silent on how credit support annexes (CSAs) should net out exposure.  Mark-to-market accounting leaves banks vulnerable to swings in swap valuation that XVAs cannot mitigate.  This makes it imperative for central counterparties (CCPs) displaying derivatives to disclose CSA details.  The CSAs set boundary conditions within which XVAs adjust; disclosure shows the world where mark-to-market accounting will cause a swap to breach its boundary.

Some institutions forget moderation and fall for investment banks' wild pitches.  The i-banks' quants are supposed to use XVAs to think through the market's effects on swap pricing.  They should not use these adjustments to gouge unsophisticated clients out of a few more basis points.  Industry bodies need to pitch in.  The Global Financial Markets Association (GFMA) and the International Capital Market Association (ICMA) should work out some robust guidelines for financial institutions that employ XVAs.  Applying the same guidelines across derivatives markets for interest rates, commodities, and currencies gives the "law of one price" stronger meaning for global investors.  It will also keep bank trading desks within their Basel limits and internal risk appetites.  

Friday, March 28, 2014

Thursday, March 27, 2014

Tuesday, March 25, 2014

The Haiku of Finance for 03/25/14

Bitcoin tax treatment
Not currency after all
Fiat still matters

IRS Ruling Destroys Bitcoin's Usefulness As Currency

The IRS has ruled that Bitcoin is an asset, not a currency.  Thank a government agency for some much-needed common sense.  The sound you hear right now is the crying of thousands of techie wanna-bes who thought their precious sets of digits were legal tender.  They'll be better off using seashells as payment.

The description of a Bitcoin transaction for coffee from that Bloomberg article says everything about how inefficient and stupid Bitcoin would be as a currency.  Anyone using dollars to buy coffee - or any other good or service in the real economy - would never have to pay a capital gains tax.  Using Bitcoin means realizing a gain or loss for part of one's Bitcoin holdings.  No one outside of a primitive barter economy or a hyperinflating modern economy would exchange an asset for an asset but that's what Bitcoiners will have to do in the US.

Hard asset hedges against hyperinflation must be liquid and immediately verifiable in value to be useful.  Bitcoin does not pass either of those tests with this ruling.  This ruling does not in any way entice me to consider Bitcoin as a hard asset on par with other commodities like metals or energy.  The difference with Bitcoin is that sharp coders can duplicate it in the blockchain.  This renders its authenticity questionable.  No one can duplicate oil in the ground, metal in a mine, timber in a forest, or inventory in a warehouse.

The clarification of Bitcoin mining as an income-producing activity is an awesome slap in the face to nerds who thought they could get rich for free.  Taxing this "income" at the value of Bitcoin when it was mined means miners may suffer losses if the price of Bitcoin declines in dollar terms.  Let me repeat that so nobody misses it.  Bitcoin mining income is the only type of ordinary earned income that could potentially be subject to a loss greater than its earned value.  Think about how this would destroy a nerd's wealth if the price of Bitcoin crashed.  Tax accountants are going to laugh when a Bitcoin client shows them a mining record worth $600, producing a tax liability of around $150, and the remaining Bitcoin turns out to be worth a couple of bucks.  Miners are going through a lot of effort creating Bitcoins at a peak price just to incur tax liabilities they won't be able to pay with their remaining loot.

The ruling will obviously create demand for an ecosystem that can record and verify crypto-currency transactions independent of a blockchain.  Accountants won't sign off on a Bitcoin client's tax forms unless they can file something like a 1099 verifying its value.  This destroys the libertarian fantasy of an unregulated anonymous economy but that's the only way Bitcoin users can stay out of tax trouble.

Bitcoin is now just another digital asset.  Other digital assets like marketing data and intellectual property have real value because they can produce a tangible benefit for their owners.  Bitcoin confers no such value.  It is just another conveyance.  The effort to produce it will be a nuisance at best and a tax loss at worst.  Real currencies are so much more useful.  

Monday, March 24, 2014

The Haiku of Finance for 03/24/14

Revolving debt door
Rolling short-term payday loans
Escalating fees

Gullibility, Distractibility, And Availability In Undue Influence

Dr. Patrick O’Reilly, author of Undue Influence: Cons, Scams and Mind Control, shared his wisdom today at the Commonwealth Club.  I learned enough about three major definitions - gullibility, distractibility, and the availability heuristic - to reduce my own chances of getting ripped off.

Gullibility is our natural state during periods of emotional vulnerability.  We accept presented information less critically when we are weakened by stress or trauma.  Distractibility from noise, crowds, and everyday details diverts our attention from critical thinking.  The availability heuristic is the human tendency to accept vivid imagery that has an emotional impact.  These biases combine with other forces to enable con artists to rip people off.  Read Undue Influence for more details on fallacies and traps.  

This line of work is relevant to me for a couple of reasons.  I first encountered multilevel marketing (MLM) scams during my active duty military service in the mid-1990s.  I knew enough about how these schemes worked from the junk mail I used to receive in college.  Several fellow officers pitched me MLM ideas of various stripes, all of which I rejected once I realized what they were.  I was very disappointed that people who pledged to live honorable lives were trying to prey on people junior to them in rank.  I was very polite and professional when I declined all further contact with these losers.  

My most severe encounter with fraud came a few years ago in San Francisco.  One very charming but disgusting veteran wore falsified valorous decorations on his uniform while defrauding donors who supported veterans organizations.  American Legion Post 911 in San Francisco was the vehicle for this scam.  That post's continued existence brings shame to the veterans' community of San Francisco.  The victims and incurious dupes who continue to enable the primary con artist's fraud don't strike me as particularly vulnerable or easily distracted.  They are mostly accomplished professionals, making their continued collaboration with a scammer all the more inexplicable.  Social proof probably plays a role among people who can't bring themselves to admit being hoodwinked over cocktails at their private club.  I accept that they don't want to explain themselves to me.  They will eventually have to explain themselves in court.

Bernard Madoff's Ponzi scheme proved that even successful investors fail to perform due diligence when someone in an affinity group possesses asymmetric information.  That's the best explanation I can find for high-profile fraud among the elite.  Extraordinary claims of fantastic results may seem completely plausible to high achievers who are accustomed to obtaining extraordinary results themselves.  It takes a Herculean effort to show them the truth.  I'm up to that challenge and I have facts on my side.  Bring on the "Mickey Mouse" opposition.  

Financial Sarcasm Roundup for 03/24/14

I'm typing this roundup while listening to a web conference on some opportunity.  Further analysis will tell whether that opportunity is worth my time.  Sarcasm is always worth my time.

Exporting US energy is becoming a hot issue once again.  The oil shocks of the 1970s scared America into keeping its dwindling petroleum supplies onshore.  Now technology lets us tap huge shale deposits and America has plenty of hydrocarbons.  Everyone ignores the steep decline rates of shale oil and gas wells.  The push for exports will probably succeed just in time to see shale production flatten out.  Shale wells will produce tiny amounts of product for decades after their decline cliffs.  That means we can expect to sell a couple of barrels per day to Europe just after these multi-billion dollar LNG terminals on the Gulf Coast are ready.

China doesn't want the Fed to raise interest rates.  Beijing's rationale is simple.  Rising US interest rates would cause the value of the US Treasuries in China's foreign reserves to fall.  China needs that financial reserve to backstop the wealth management products that are starting to blow up its shadow banking system.  I don't think the Fed is geopolitically savvy enough to use its interest rate power as a bargaining chip.  They're supposed to be politically independent while the Treasury Department handles the heavy lifting with other countries.

Mme. Lagarde wants the US to show more support for the IMF's reforms.  I interpret this as a veiled request for the US to stay engaged with the IMF's efforts in Europe while Ukraine is in play.  The IMF's funding of the European troika's bailouts would mean little without US backing (and presumably the Fed's extension of dollar swap lines to the ECB).  The troika cannot afford any distractions while its shock therapy for the PIIGS is under attack from civil unrest and its rescue of Ukraine has just begun.  BTW, I'll bet Mme. Lagarde was really hot when she was younger.

The web conference is over and so is this blog article.

Alpha-D Update for 03/24/14

It's time for another portfolio refresh.  All of my covered calls on GDX, FXA, FXC, and FXF expired unexercised last weekend.  I renewed all of those call options for another month.  It's nice to pocket a little bit of cash once in a while.  I have not changed my reasons for holding some exposure to gold mining and foreign currencies.  I am not confident that the Federal Reserve's experiments with the US dollar will end on a happy note.

I continue to hold a long put position against FXE.  I still do not think the euro will hold together in its present form over the long term.  I have several months until this position expires, so I will review it each month in anticipation of a sale prior to expiration.  I would rather pocket a gain then let it go to waste.

I have not initiated any other positions this month.  I remain interested in timber REITs and public storage REITs as additional hard asset hedges.  Frankly, I remain interested in several mining and energy plays as hard asset hedges but very little in the markets is attractively priced right now.  I never overpay for anything.  

Sunday, March 23, 2014

The Limerick of Finance for 03/23/14

China's money rate is on a streak
Can't tell when its sharp rise will peak
This quiet bailout
Gives Beijing its clout
Shadow banking system is still weak

Money Flow Index, Money Flows, And Fund Flows Are All Different In Quality

Flows can be fun to watch.  Morons find them boring but geniuses like Yours Truly know what they mean.  It's too bad that some market flows are nonsense while others matter just a little bit.  Today I'm going to sort the wheat from the chaff.

The money flow index (MFI) is one type of flow that I safely ignore.  It is a technical indicator.  Academic studies have proven many times that technical indicators don't count for jack squat.  Investopedia notes that traders use a stock's MFI to indicate a trend reversal.  I say it indicates no such thing.  A simple average of a stock's three key prices during a day's trading range has no more statistical validity than the result of three coin tosses.  Using a random result to spot a trend is really silly.

The Wall Street Journal's Money Flows table is slightly more useful than a technical indicator.  The breakdowns of individual stocks, sectors, and the broad market aren't range-bound like the MFI.  The difference between buying and selling strength is a simple ratio.  It is a much purer supply/demand relationship than the MFI because it accounts for a total dollar volume of transactions and isn't smoothed with internal averaging.  This is meaningful in conjunction with a fundamental analysis that estimates an intrinsic value for a stock.  The ratio indicates whether the market is ignorant of something the intrinsic value reveals.  If I think a stock's intrinsic value is worth less than its market value, but I see strong demand in this money flow data, I'm going to wonder what crazy plant the institutional investors are smoking by bidding up an overvalued stock.  This ratio is also useful in evaluating index funds that track broad averages.  If the economy's P/E is above its long-term average of about 14, and the WSJ money flow ratio for the total market shows strong demand, I will once again wonder why institutions are so desperate to pay a premium.  Birinyi Associates uses a variation of this money flow analysis without my sarcastic flair.

The most useful flows I've discovered are the ICI's statistics on weekly and monthly fund flows.  The weekly estimated long-term mutual fund flows are the most frequently cited series.  Mutual fund data is a barometer for individual investor sentiment because investment companies market actively managed products to retail investors.  I often see Zero Hedge writers go nuts about this data every week.  Lemmings rush into mutual funds when they get greedy in bull markets and stampede out when they're terrified in bear markets.  Market panic is a value investor's gift-bearing friend.

I needed to explain all of these flows because some folks are bound to get them confused when they go looking for stock market sign posts.  The WSJ money flows and ICI data series are probably even less useful than the "Warren Buffett Indicator."   The MFI is not useful at all.  These things are rough guesses at market sentiment but they cannot be the sole decision triggers for any competent investment decision.  That only comes from detailed fundamental analysis.  I exist to clarify and explain complex ideas.  I enjoy showing off my intellect.  Look upon my works and despair, puny mortals.  

Saturday, March 22, 2014

The Haiku of Finance for 03/22/14

Frontier investors
Seek new Africa markets
Country risk still looms

Americans Lulled To Sleep By Pumped Markets

I have noted for some time that Americans are oblivious to the main force driving their portfolios to the moon.  That would be central bank quantitative easing, all around the world.  One BIS report from 2013 said it all.  I'm not linking to it this time.  Go find it yourself.  Earn that knowledge with some work.

Americans typically don't save their paychecks and invest for retirement.  The poor don't have much income to save, although staying off booze and cigarettes would help.  The middle class has been instructed to believe in Social Security's mythical solvency.  That leaves the bottom four quintiles at the mercy of the top quintile.  The serf population will be quite large and desperate after the next crack-up.  I expect to have my pick of the litter as itinerant labor after I become their overlord.  This is where I would insert a sinister laugh track if I cared enough.

I do not listen to the nonsensical chatter spewing from financial advising media.  I did when I was a financial adviser from 2005-2006 and much of it made little sense to me.  I was terminated as a financial adviser because people don't want to hear the truth.  The retail salespeople attached to investment banks are riding the pump scheme for all it's worth.  I don't expect them to wake up.  The few financial advisers with sense enough to pursue independent paths can't compete with central banks determined to pump asset classes to the moon.  That's why I'm not a financial adviser.  No one wants my advice and I don't give any.

Lemmings can enjoy the wealth effect of pumped markets while it lasts.  Taking out HELOCs ended badly for many home "investors" after 2006.  Everyone has forgotten how that ended.  People are going to learn the hard way all over again.  America went to sleep after the financial crisis of 2008.  I'm not trying to wake the country up.  Other investors' pain will be my gain.  

Friday, March 21, 2014

The Haiku of Finance for 03/21/14

State success index
Small states live within their means
California fail

Success Metrics In South Carolina And California

I attended the San Francisco Republican Party's annual Lincoln / Reagan Dinner last night.  Governor Nikki Haley of South Carolina spoke about her efforts to improve conditions in her state.  It's appropriate to compare that state to California so we can figure out what we're doing wrong.

The Tax Foundation's 2014 State Business Tax Climate Index shows that South Carolina is #37 and California is #48.  That's a notable difference and it's embarrassing to see California near the bottom.  The top states are those that do without one of several major taxes.  That means even California's Proposition 13 limits on property taxes can't make up for high taxes in other areas.  Tax burden isn't everything in measuring a state's economic health.  Governing's 2013 analysis revealed that the above tax index had little relation to levels of wages or employment.

If taxes don't tell the whole story on a state's competitiveness then we need broader measures.  The Mercatus Center's "Freedom In The 50 States" index ranks South Carolina 15th and California 49th.  Gee, that's a huge difference in personal and economic freedom.  The Cost of Government Center's assessment of each state's contribution to an individual's regulatory burden shows that Californians have to work 20 days longer than South Carolinians each year to be free of regulations.  The invisible tax of regulation matters as much as the formal tax burden.

The US Chamber of Commerce Foundation's Enterprising States project ranks states across a number of economic measures.  California beats South Carolina in Performance and Talent Pipeline, but loses to that smaller state in the other four broad categories.  My state's ranking in the Talent Pipeline sub-categories reveal that we're eating our seed corn.  The state does well in high school AP but poorly in college affordability and degree output.  I expect our most talented high school students to exit California for cheaper colleges elsewhere.  Blame our state's teachers' unions for this likelihood.

One very important measure of a state's ability to manage its affairs is its credit rating for general obligation bonds.  Pew Charitable Trusts tracks the US states' S&P credit ratings in a handy infographic.  South Carolina has been consistently high at AAA or AA+ for over a decade.  California is at the absolute bottom of all of the states.  It is shameful to see developing nations with higher sovereign credit ratings than the US's most populous state.  Compare our state's debt burden to the poor results we obtain in the rankings above to see the extent of our dysfunction.  If our tax burden according to the Tax Foundation is so high, we should have no difficulty repaying our state's debt and earning a higher credit rating.  The persistently high tax burden and low credit rating indicate uncontrolled state spending that is not moving the needle up in the other indexes' very important success metrics.

In fairness to alternative views, Good Jobs First's "Grading Places" 2013 report objects to the findings of the Tax Foundation and other business climate indexes.  I don't think any single index will ever perfectly describe a state's KPIs but we have to start somewhere.  Some states have unique natural resources that confer windfall advantages, like North Dakota's shale boom.  California has abundant natural resources, so we should be experiencing perennial financial windfalls instead of persistent budget deficits.  Our state's problems stem from its people.  California has become home to too many dingbats, bums, and morons.  We elect leaders in Sacramento who reflect those degraded tendencies.  The US federal system of government allows the states to be laboratories for policy innovations.  California's lab experiments need a reset at the ballot box.  

Thursday, March 20, 2014

The Haiku of Finance for 03/20/14

Innovation risk
Duplicate extant patent
Search the filings first

Generating Alpha From An IP Portfolio

I suspect that some of the concepts useful in financial portfolio management also apply to managing a portfolio of intellectual property.  The IP portfolio will not be as liquid as a basket of stocks or bonds, but there may be a common intellectual framework for all of these asset classes.  Intellectual Asset Management refers to IP finance and valuation in ways that beg for more analysis.

Notional IP portfolio holdings must start with bottom-up valuation.  Standards from USPAP, IVSC, FASB, and IFRS/IASB establish baselines for assessing IP value.  WIPO's list of documents on IP valuation help build out the methodologies needed.  Valuation matters for establishing an investment's entry point.  I wouldn't pay a million bucks for some patent that's only worth a nickel.  The "cost" method reminds me of equity valuation methods that use book value and Tobin's Q.  The "income" approach is pretty much the discounted cash flow method that most equity analysts should recognize.

The illiquid nature of IP means a pure-play investment in a bunch of intangible assets would bear more resemblance to a private equity investment than a public stock.  Liquid proxies for an illiquid patent portfolio do exist.  These include ETFs based on the Ocean Tomo 300 Patent Index.  The simplest way to measure the alpha of a pure-play IP portfolio is to compare it to that index's return over whatever holding period is relevant.

There are "unknown knowns" that pose risk management challenges to IP portfolio management.  Patent quality matters.  There must be some way to perform statistical analysis of an IP portfolio's quality beyond just number of filings by country or sector.  WIPO's PATENTSCOPE database and the USPTO probably have enough data to make this analysis worthwhile.  Managing an IP portfolio's risk should consider litigation trends within the taxonomy of patent classifications.  The risk breakdown would assign different risk weights to electronics, hydraulics, or whatever to avoid overconcentration of ownership in some class subject to heavy litigation (like software).  My Google searches for "patent portfolio theory" and "patent portfolio race" reveal a notable amount of theory addressing these issues.  Finally, I wonder whether IP portfolio considerations should differentiate by type of IP:  patent, trademark, copyright, etc.  A diverse portfolio containing many IP types may achieve an optimal risk-return tradeoff, or it may be an encumbrance to the search for pure-play returns.

Investing in IP or IP-heavy companies reminds me of the "innovation premium" theory.  I proposed my own metrics for an innovation premium in an Alfidi Capital blog article last year.  Those metrics can be weighted differently to account for qualitative differences; i.e. "number of patents filed" can carry a smaller weight if patent quality declines.  I feel like publishing a longer research report on generating alpha from an IP portfolio but I will only do so if it adds something not already covered in WIPO's literature.  Good knowledge of IP valuation would make a huge difference in technology transfer from research laboratories to the marketplace.  I would consider commercializing tech from a government or university lab if I understood how its valuation fit into a larger portfolio.

Full disclosure:  No positions in any investment products mentioned at this time.

Wednesday, March 19, 2014

The Haiku of Finance for 03/19/14

Filing patent claim
Prior art matters a lot
Cannot duplicate

Chinese And US Patent Lawfare

Today I attended CALOBA's presentation on how Chinese companies handle US patent litigation.  I have not found the researchers' slides or data in public media at the time I wrote this article.  The research concluded that Chinese companies get sued a lot and are prime targets for US patent trolls.  The report's authors used Lex Machina to mine databases on patent lawsuits, so Big Data is finally transforming the legal field.  The trends that CALOBA's invited panelists discussed made me think of how Chinese companies are vulnerable to deliberate lawfare tactics.  I can summarize the Chinese vulnerabilities they identified, in the best non-lawyer way I can muster.

Vulnerability #1:  Speak no evil.  Chinese companies underestimate the amount of documentation they must provide during discovery in US-based litigation.  They are unaccustomed to such extensive transparency.  Their reluctance to disclose emails, meeting transcripts, and other records puts them at risk of losing cases in US courts.

Vulnerability #2:  Lost in translation.  Chinese companies rely too much on English language translation services.  The panelists presented some anecdotal observations that engineering diagrams would have withstood cross-examination in a US patent hearing if they had been accompanied by original descriptions in English.

Vulnerability #3:  What goes on in country doesn't stay in country.  Chinese executives who are unwilling to travel to the US for a trial hurt their case.  American juries want to hear the Chinese executives' side of the story.  The panel recalled a funny story about a Chinese company that ignored a default judgment only to travel to the US for business afterwards and see their trade show exhibit seized.  They must have assumed the court system would have a short memory.  The long arm of US law has a very long memory.

Vulnerability #4:  Not enough lawyer firepower.  I'm not sure whether Chinese companies take their legal system as seriously as Americans take their own system or give their attorneys as much prestige.  The panel implied that typical Chinese corporate in-house counsel either doesn't have enough rank within the company to be heard or has additional duties in low-level management.  I should have asked the experts on hand to clarify the social standing of Chinese in-house counsel but it was hard to be heard over the silly questions some dingbats in the audience were asking.

The WIPO published China's own description of its utility model patent (UMP) system in September 2012.  I read stuff like this all the time.  The US Chamber of Commerce published a detailed description of China's UMP regime in November 2012.  I like the US description better.  I can't fully trust anything from the Chinese government until they complete their planned legal system reform.  The US report clearly identifies that China's focus on pushing raw numbers of patent filings has driven a decline in patent quality.  This decline has invited the attention of patent trolls whose legal tactics outwit Chinese companies in US courts.  The US has begun fighting its own patent trolls while China remains vulnerable to its own trolls.

I'll offer some broad considerations for US public policymakers, business lobbyists, and entrepreneurs in light of the above conditions.  US regulations and laws discouraging patent trolls may limit the ability of US firms to litigate Chinese IP theft.  It is too early to tell whether Chinese legal reform will accommodate the kinds of multi-pronged IP strategies US companies are accustomed to using in the US.  Patent claim strategies must account for prior art to avoid duplication.  Startups have tighter budget constraints and shouldn't pursue expansive patent strategies; they can't afford to patent much besides their core tech.  All of that wisdom is totally a stream of consciousness blast, but that's how Alfidi Capital does business.  Take it or leave it.

The broad drafts of US patents and the inflexibility of Chinese patent appeals illustrate the asymmetric advantages the US possesses in any potential lawfare contest.  The US's ability to conduct lawfare should be a source of national pride.  This country graduates more lawyers every year than the rest of the world supposedly has in stock.  God bless America for winning the lawfare arms race early.  

Tuesday, March 18, 2014

US Investors Should Not Fear Belgium

My daily perusal of Zero Hedge reveals that alarmism never takes a day off.  A corrected Reuters update to monthly demand for Treasuries set off some paranoia about hidden agendas.  One reports clerk at Treasury probably made a fat-fingered mistake and had to re-do the monthly holdings report.  Corrected numbers by themselves are not sufficient evidence for a conspiracy.

The updated US TIC numbers for January 2014 reveal Belgium to be the third-largest holder of Treasuries.  Note that Russia hasn't dropped off the list just yet; we'll have to wait until the March TIC data release in May to see if some oligarchs are moving around.  Anyway, note that the line for "Caribbean Banking Centers" really refers primarily to the hedge funds domiciled there, not the island countries' sovereign cash.  The line for Belgium probably means much the same.  GlobalFundData notes that there are plenty of hedge funds in Belgium.  The Treasury press release for today's TIC data refers to "foreign residents" rather than sovereign governments.  Maybe a bunch of European aristocrats used their family banks to buy Treasuries.  They probably got a good deal as the Fed began backing away from its QE role.

We have nothing to fear from Belgium.  Zero Hedge can relax.  

The Haiku of Finance for 03/18/14

High-speed trading curb
Move server outside exchange
Connect to dark pool

Gaming Startup Solutions In Search Of Problems

The Game Developers Conference is happening this week in San Francisco.  I couldn't get a free ticket, and I don't pay to attend business events when there's an option to attend for free.  I did attend a couple of social events yesterday where startups displayed their latest solutions in search of problems.  The problem I have with these solutions is that their creators won't find a problem they can solve.

I need to hear founders describe the really bad market problem they are solving before I can take them seriously.  I'm not convinced that the world's disorganized knowledge sources constitute a problem.  Search engines already do a pretty good job of sorting quality content.  Gamifying search will probably incentivize people who don't need to be incentivized.  

Entrepreneurs who dream of cracking some big market should break down their opportunity into the TAM / SAM / SOM chunks.  Startups who think they can bite the whole SAM within two years of getting funded need to reassess their scalability.  I think the structure of a game also determines its positioning in the market, just like engineering and design determine a physical product's positioning.  Games with really involved storylines are great for people who can sit focused for hours.  They are not great for mobile users who play furtively at bus stops or waiting in retail lines.  Short games with simple functions and many levels make more sense for mobile.  I've never seen anyone playing some epic multiplayer quest on mobile.  Maybe I don't hang out with enough hard-core gamers.

Use case data helps establish a customer's LTV.  Game startups without use case data might as well go get some.  Beta testing isn't just for working out bugs in the UX.  Testing means discovering whether a measured engagement generates enough revenue to make mass distribution worthwhile.  It also means A/B testing to see what UI the customer prefers.  

There is a gaping hole in enterprise computing for Big Data solutions addressing human resources and supply chain management.  The first startup to deploy something gamified for these two verticals will own a big chuck of enterprise IT for years.  I still see game developers pushing pure games on a culture that is already saturated with distractions.  Turning game knowledge into something that measures and enhances enterprise productivity solves a huge problem.  I can just see status-conscious employees collecting gold stars for turning in reports on time and collaborating with the maximum number of colleagues.  Those gold stars could be tickets to promotion.  

Programmers flock to gaming where compensation is lower than in enterprise solutions.  I am amazed that intelligent programmers willingly take pay cuts to work in crowded sectors just because they're more fun than solving business problems.  Even scientifically educated people can be irrational.  Gaming up HR and logistics is boring but probably very lucrative.  

Games and social apps are easy to make.  That's why so many unnecessary ones exist.  The success stories do the things I mentioned above plus a whole lot more.  The ones that fail contribute to the survivorship bias problem in the tech sector because they don't leave any trace of why they failed.  It wasn't just that they never solved a problem.  They never looked for the problem in the first place.  

Monday, March 17, 2014

The Haiku of Finance for 03/17/14

Bitcoin denial
Dude said he's not creator
If not him, then who?

Financial Sarcasm Roundup for 03/17/14

Here's a shout-out to all of the stupid losers who think a happy Saint Patrick's Day is about getting plastered as fast as possible.  True geniuses like Yours Truly know how to enjoy public festivals responsibly.

The Transatlantic trade pact partners are still yapping about what a great deal they're going to get.  Talk is cheap.  It's a good thing the US typically names political donors and trust fund babies as its ambassadors to Europe.  Those folks have the contacts to reach back to the US business community and ask for negotiating instructions.  This trade pact will be a boon if it makes German chocolate and Italian salami cheaper to buy in San Francisco.

The FDIC begins its legal pursuit of Libor manipulation.  This is more than a year after London regulators realized how tough it would be to bring large banks to heel.  Don't think this is going anywhere.  Regulators have to go through the motions and levy wrist-slap fines so they can find future employment with the same miscreant banks.

New York just knocked London off its pedestal as the world's top financial center.  Go USA, red / white / blue and all that jazz.  Maybe a bunch of Russian "oily-garchs" decided to move some business out of London last year.  I can't believe San Francisco isn't in the Big Four.  What's wrong with this town?  We've got plenty of cash laying around.  Silicon Valley billionaires are doing their part for M&A by adding more app makers to their ecosystems.

Low-income Americans are stuck in poverty.  These people are like that old TV commercial where that old lady says she's fallen and can't get up.  There are plenty of reasons why the poor can't find decent-paying work.  The minimum wage, illegal immigration, and health care mandates make it too expensive for small businesses to hire more workers.  Poor folks will have to take multiple part-time jobs to raise their living standards.  If it's any consolation, that's also the future of work for most of the highly-skilled middle class.

St. Patrick's Day means some leprechaun is stumbling towards a pot of gold with a drink in hand. Now is the time to follow him.

Sunday, March 16, 2014

The Limerick of Finance for 03/16/14

Yuan trading band doubled wide
China thinks it has nothing to hide
With growth on the wane
Any move is in vain
This currency's value can slide

Deep State Financial Order Of Battle Between Russia And The West

Mike Lofgren's "Anatomy of the Deep State" for Bill Moyers sheds new light on the elite actors shaping national and global policies.  This analytical framework allows consideration of both state actors and non-state actors shaping the confrontation between Russia and the West over Ukraine.  Military analysts discuss "orders of battle" when nation-states face off in a military confrontation.  Financial analysts may compile a financial order of battle in parallel for a conflict's non-violent dimension.  Ukraine Crisis' excellent infographic depicts the financial battlefield.  Here is the Alfidi Capital contribution to the global dialogue.


Radio Free Europe / Radio Liberty identified some of Russia's deep state players in 2012.  The Carnegie Endowment recognized in 2011 that Russia's deep state security operatives periodically emerge to harm the Putin regime's opponents.  Anywhere from a few dozen to a few hundred people close to Vladimir Putin control a blend of public and private mechanisms that apportion wealth in Russia.  They have large but not unlimited financial resources.

Russian billionaires have lost significant wealth since the crisis began.  The advance warning that allowed them to escape forced bank recapitalizations in Cyprus is present in this crisis, but the escape routes to more hospitable climes may not be available this time.  Repatriating personal assets to Russia will make them subject to the kinds of political schemes they sought to avoid by relocating abroad.

Gazprom is Russia's state-connected private energy behemoth.  It presents "Gazprom Ukraine Facts" (do a Google search for that term) telling its side of the Russia-Ukraine gas dispute.  Reuters notes that Rosneft is interested in buying an Odessa oil refinery if Russia's state bank VTB forecloses on its unpaid debts.  The tension between Russia and Ukraine over Ukraine's unpaid gas subsidies was one of the triggers for this crisis.  Alfidi Capital believes that any Gazprom and Rosneft financial interests in Ukraine provide both a pretext for further Russian military provocations and pain points the West can target with financial restrictions.

The Financial Times reports that Russian companies have moved large amounts of cash out of Western banks in anticipation of sanctions.  Where those assets end up is anyone's guess but there aren't many places they can go to avoid SWIFT transfer restrictions.  The record drop in Treasuries held in custody at the Fed has Bloomberg and other media wondering whether Russia's central bank is moving its holdings beyond the reach of US sanctions.  It is too early to tell whether Russia intends to sell some or all of its Treasuries.  The ruble's value against the dollar has severely weakened in recent weeks, so the longer Russia waits to sell, the less local cash they will receive.

Putin's Palace is an impressive redoubt that sanctions cannot reach, but the oligarchs who helped build it may not have the patience for a protracted conflict that hurts their fortunes.  There is no evidence in public media  that Russia has the financial equivalent of a Tsar Bomba it can drop on financial markets.  No one would expect a financial WMD that will show Kuzma's mother to the world.  Then again, Dr. Strangelove ended with the detonation of a Soviet cobalt bomb after several Americans were admonished not to fight in the War Room.


Alfidi Capital has already assessed Ukraine's financial condition.  Many Western commentators have missed how things got so bad.  Ukraine was the third largest recipient of US development aid during much of the 1990s.  Much of that aid appears to have been wasted or looted.  Yulia Tymoshenko, a key leader of Ukraine's nationalist political coalition, is by some accounts an oligarch.  Ukraine's oligarchs are divided against themselves; Dmytro Firtash, a Tymoshenko opponent, has been arrested for allegedly gouging Ukraine to help Gazprom.

Ukraine's dire financial straits and rich physical assets define the country more in the role of prize than combatant.  This East European Gas Analysis map of Ukraine's gas pipelines depicts two very important characteristics that other maps ignore:  compressor stations and gas fields.  Russia cannot cut off gas supplies to Ukraine without cutting off its European customers as well.  Russian forces would have to control all of those stations throughout the entire country to apportion gas flows as rewards or punishments.  Chevron agreed in 2013 to develop the Olesska shale gas field in Ukraine's west.  Shell agreed in 2013 to develop the Yuzivska field in Ukraine's east.  It should go without saying that infrastructure and fields in Ukraine's east are in more immediate danger of falling under Russian control than those in the west.  Control of the Ukraine pipeline network and untapped oil/gas fields is a major strategic prize at stake in Ukraine.

DEEP STATE United States

The White House published an Executive Order on March 6, 2014 authorizing the government to act against anyone who facilitates Russian armed intrusions into Ukraine.  The term "United States person" is defined to include corporate entities, and this includes the foreign branches of US banks and corporations.  This EO is clearly targeted against a handful of Russian citizens and Ukrainian collaborators who have directly interfered in Ukraine's internal politics.  It is not intended to silence any foreign policy debates here in America.  Paranoiacs can relax.  The Magnitsky Act provides further US leverage against specific Russian officials who commit human rights violations.  It is unclear at this time whether American sanctions will prohibit American ownership of Russian-derived securities (ETFs, mutual funds, ADRs of Russian companies, etc.) traded on US exchanges.  That is another shoe waiting to drop, depending on which Russian companies appear on the US Treasury's Office of Foreign Assets Control (OFAC) lists and how the SEC interprets its role in sanctions.

A potential Russian sale of all of its central bank's Treasuries would liquidate about 1% of the US government's outstanding marketable debt securities.  The Federal Reserve has reduced its commitment to quantitative easing but this is an easily reversible decision in an emergency.  The Fed could buy all of Russia's liquidated Treasuries once they were released to the world market, although the difficulty of getting around sanctions barriers would delay the transactions.  I don't think Janet Yellen wants to run afoul of OFAC.  The US Treasury would probably have to authorize the Fed to deal with non-US financial institutions that aren't on the NY Fed's primary dealers list in such an emergency.

US companies may not be very farsighted; it is not clear whether they have considered moving cash out of Russia to avoid retaliatory sanctions from that country.  Indeed, Exxon still appears fully committed to its JV with Rosneft to develop multiple energy projects.  That may now be an untenable arrangement.  A new regime in Crimea will imperil offshore oil and gas leases granted to Western supermajors.  A lot of high-priced MBAs didn't see this one coming.  US-based multinationals that do not have contingency plans for non-Russian cash transfers remain exposed to any Russian financial countermoves.  

Implications for financial markets

The conflict between Russia and the West over Ukraine has a military dimension that is fortunately confined to small areas.  Alfidi Capital's Third Eye OSINT has already assessed Russia's likely military moves.  The remainder of this conflict will take place largely in financial markets and trade relations.  The deep states of the US and its allies have an overwhelming advantage in financial capabilities and will likely inflict more pain on Russia's deep state than the converse.  This is a likelihood, not a certainty.  Investors watching the crossfire can avoid getting trapped on a financial battlefield.

Full disclosure:  This author does not own any positions in any securities of Ukrainian or Russian companies.

Saturday, March 15, 2014

The Haiku of Finance for 03/15/14

Fast food bankruptcies
No one can afford mall food
Too poor to dine out

Silicon Valley Billionaire Wastes Fortune On Life Insurance

Some Silicon Valley titan just dropped serious coin on the world's most expensive life insurance policy.  This unnamed billionaire is probably very intelligent in her or his business career.  That talent didn't prevent this very stupid decision.  There are cheaper ways to incentivize one's heirs while leaving them the bulk of a hard-earned fortune.

This person could have pulled a George Lucas and dumped the bulk of their assets into a charitable foundation after selling off whatever enterprise they owned.  They also could have set up separate charitable remainder trusts for each beneficiary among their next of kin and recorded major tax deductions.  Charitable gifts work pretty much the same way for publicly traded securities, restricted shares, and entire private enterprises.  The only things that would be difficult to gift might be "future assets" like deferred compensation from options or bonuses subject to earnouts.  If this person's financial advisory team proposed a range of options for the client's consideration then they fulfilled their fiduciary duties.  

Insurance products are among the most expensive things investment advisers can sell.  All this nameless big shot accomplished was the transfer of risk from their portfolio to a collection of insurance companies.  If one of those insurance companies ends up insolvent in the next financial crisis, like AIG was in the last one, that policy could be toast.  Life insurance has a role to play in creating an estate that will provide income in the absence of a head of household.  This billionaire doesn't have that problem.  Their life insurance policy didn't need to be this big.  Someone just wasted a lot of money for more peace of mind.  

Friday, March 14, 2014

The Haiku of Finance for 03/14/14

Moving Treasuries
Avoid sanction custody
Could Russia sell them?

International Trade Centre Scores Big With Big Data Maps

I am not easily impressed but multinational institutions continue to impress me with Big Data tools.  I noticed that the UN/WTO International Trade Centre maintains several search maps of data on trade and investment.  I don't believe I've ever seen them before.  They look too useful to ignore.

The ITC Trade Map covers the import/export side of business equations.  If I were analyzing a country whose economy I believe is export-driven (i.e., Australia's natural resource exports), I would examine its trade flows with major customers (i.e., China) to see periodic changes.  This would help me assess directional changes in the exporting country's GDP and currency.

The ITC Investment Map has FDI data that may prove useful to me as I try to understand why foreign investors target some sectors and regions within the US.

The ITC Market Access Map shows further data on tariffs and quotas.  I am not an expert on tariff systems but knowing where to find them will help me understand barriers to entry in the sectors I routinely follow.

The ITC Trade Competitiveness Map is an indexed comparison of how different countries compare in the competitiveness of their products.

The ITC Standards Map looks like it's the most boring of the available maps.  Maybe lobbyists and labor unions like to wade through reams of conduct rules.  I don't have much patience for that in my analysis but I would like to give it at least a cursory look.

The bad news is that access to these databases is password restricted.  Users from developed countries can only obtain limited access for free.  I'm based in the US and I'm sure as all get-out not paying a penny for something that should be free.  The US is the UN system's largest source of funding and we should insist that this data be free to the entire world as a global public good.  I haven't tried to register for an account yet.  Let's see how efficient this UN entity proves to be in processing my requests for access.  I can't wait to test drive as much data as they'll let me have.  

Make Digital Marketing Trustworthy

I attended another Meetup last night - "Trust and Native Advertising."  My name appears on that page as a registered attendee in case you don't believe me.  I go where cool stuff happens and no one can stop me.  The wisdom of an accomplished journalist, an experienced marketing practitioner, a pioneering tech media publisher, and two social media entrepreneurs all reflected the importance of trust in building relationships.  Silicon Valley Watcher knows that building trust takes a lot more time and work than riding a trend.  My own interactions with the crowd of entrepreneurial wanna-bes who attended showed me that hardly anyone is ready to be trusted.

There's a lot of common sense in building trust into marketing.  The seminar's marketing expert implied that trust starts internally when startups take their marketing function as seriously as anything else.  Trusting your outside marketer to be a sanity check that's integrated into your team is essential.  I trust that wisdom from experience with similar relationships that failed when outside advisers weren't integrated well.  The panelists noted a natural divide between digital natives and digital immigrants but I don't think that's a big problem.  Each evolution in tech brings us more intuitive devices.  Even babies can use an iPad, so figuring out messaging and profile management can't be that hard.  

One of the presenters shared a good tactic for pushing content into social media channels.  Versioning the same content in multiple ways for a few channels is more efficient than blasting the same content to many channels.  It also avoids wasting time from repeatedly customizing content for multiple channels.  I also liked hearing about how well-known bloggers and journalists are influencers who can magnify a brand story.  I think reaching out to influencers is harder than the panelists made it sound.  Popular bloggers must get inundated with requests for guest posts and backlinks.  Some kind of drip campaign targeting a handful of key bloggers would probably work if it demonstrated how a brand's content was evolving.  

I mentioned at the top my disappointment that a lot of the people attracted to these types of Meetups aren't ready to be trusted.  Their conversations with me, and their statements during Q&A, reveal a profound misunderstanding of what constitutes trustworthy behavior.  Some of the people running their mouths acted like they've never seen a microphone before, never spoken in public, and never left home for the big wide world.  I've blogged before about the problems people cause in San Francisco to demonstrate that I am the solution.  I see this kind of behavior at the Commonwealth Club and I used to think it was confined to elderly shut-ins who retired from careers in government cubicles.  Now I see that it also permeates today's techno-augmented youngsters.  People, if you want my trust, do your homework on the presented subject matter and ask intelligent questions.

My peeves with untrustworthy humans extend past the aspirants who populate Meetup audiences.  Web 2.0 startups that "succeed" through hype instead of earnings do so partly by ignoring the need to build trust.  Here come some stunning examples.  Facebook and Twitter will eventually face serious problems because clients who pay for targeted ads can't trust whether their audiences are real.  Both of those companies' user engagement systems are easily manipulated by paid "likes" and "follows" from phony contractors running hundreds of fake profiles out of Internet cafes in developing countries.  Yelp has a similar problem with false reviews from competitors and an algorithm that mysteriously hides valid reviews.  The obvious solution is for these companies is to hire an independent auditor who can verify the extent of fake user profiles in their systems.  The Nielsen Company figured out how to do this with audience ratings for TV and radio broadcasts decades ago and advertisers trust their methodologies.

Trust matters.  It takes a long time to build.  Its foundation is integrity in disclosing facts, processing data, and representing operations.  The Meetup panelists understood this and valued the relationships they built with influencers.  Those influencers built their reputations with integrity.  This very simple lesson in personal character went right over the heads of the majority of attendees.  That's why those people are a long way from ever building world-class companies.  

Thursday, March 13, 2014

The Haiku of Finance for 03/13/14

Digital coupons
Challenge to Groupon model
Shoppers benefit

The Dunning-Kruger Effect On Wall Street

The Dunning-Kruger effect afflicts most of humanity.  Statistically speaking, a big chunk of the human race is average to below average in ability.  These people overestimate their abilities and underestimate the abilities of those who are truly skilled.  Evidence that these people populate Wall Street and corporate C-suites is plentiful.

Studies of portfolio managers prove that the vast majority do not outperform benchmark indexes.  Check out the SPIVA scorecards for actively managed funds.  Their report titled "US Mid-Year 2013" reveals that most actively managed funds across all cap sizes underperformed their benchmarks during multiple time periods.  There were a few exceptions for international small-cap funds and some fixed income funds.  Investors who count on those exceptions to persist will be disappointed.  Vanguard's "The case for index-fund investing" report from April 2013 shows the persistent cost and performance advantages of passive investing over the long term.  The evidence against active money managers is overwhelming.  Active money management is untenable as a credible profession.

Money managers are just plain dumb.  I've met some of them at finance events.  They talk to me just long enough to steal my ideas because they have no ideas of their own.  These people have no business calling themselves skilled, highly qualified, superior, or any other such unearned term.  They do so anyway and investors keep handing them money.  Active portfolio managers are exemplars of the Dunning-Kruger effect.  The ones at the top of mutual fund companies and hedge funds-of-funds are probably also exemplars of the Peter Principle.  Analysts who made a few lucky calls one year on their favorite stocks don't necessarily have the broader perspective to manage a fund exposed to multiple sectors.

The record of managers in C-suites is just as bad as Wall Street's performance.  Big-shot CEOs love the headlines they get when they gobble other companies in M&A transactions.  They have no empirical justification for such pride.  The HBR blog in March 2011 noted the very high failure rate of M&A deals.  Knowledge@Wharton noted in March 2005 that M&A deals fail due to poor due diligence, post-merger integration problems, and other factors.  Top executives are paid to understand these forces before they commit to deals.  A lot of them obviously understand very little when they go hunting for acquisitions.  I can just imagine a Peter Principle investment banker trolling CEOs for deal flow, promising glowing media coverage of their acquisition prowess.

I'll disclose that I haven't been able to outperform any broad benchmarks myself for several years.  Outperformance isn't my objective given the immense price distortions central banks have generated in asset markets.  My objective is to outlast the finance professionals who will eventually be ruined by their faith in any of the pumped asset markets.  I also haven't acquired any companies, so I can't compete with the swinging dealmakers who throw money away on dumb buyouts.  A lot of the C-suite people may be Dilbert Principle promotees who couldn't handle the company's basic work.  How these people got promoted in finance and corporate life isn't up to me.  I'm only concerned with staying away from them so their Dunning-Kruger overestimations don't harm my life.