To borrow or not to borrow: Thoughts on US government debt

Posted on January 5, 2012 by mark

A reputable investment bank approaches you and says they’ll lend you as much money as you want for a very low interest rate. The rate depends on how long you want to hang onto the cash:

1 Month will cost you 0.01% APR interest
6 months: 0.07%
1 years: 0.11%
5 years: 0.88%
10 years: 2.02%

If you earn 3.5% on the money over 5 years which simply keeps pace with US inflation, when you pay back the principle you will be able to keep a 2.62% annual return on whatever you borrowed, based on the 5 year borrowing rate above. So if you borrow 1 million over 5 years you earn $138,046.62 in pure interest over 5 years (compounded annually).

Sounds like a pretty good deal right? $138K earned 5 years from now for nothing. I’d take it, assuming I could find somewhere to invest the money that would give me a 3.5% return, which shouldn’t be too hard.

However, if I’m fiscally irresponsible and rather than investing the cash I’m likely to spend it on hookers and blow, then it’s probably a bad idea for me to borrow as much as I can.

However, if I am that irresponsible and have a history of being a nut job, the interest rate that the investment bank charges me on my borrowings will reflect my lifestyle and will be more like 30% APR which is what many credit card companies charge once you’ve missed a payment.

The interest rates above are what America currently pays to borrow money. It’s the treasury yield curve rates. They are below inflation which means that the rest of the world pays the United States to store their money. And the United States makes money if they can get a very moderate return on any of that cash they invest. If the return simply keeps pace with inflation, they’re rolling in dough.

The interest rate the United States gets charged reflects how investment banks, sovereign wealth funds, companies and individuals feel about the United States “lifestyle” or fiscal and monetary level of responsibility.

So the question is: Can our country borrow trillions of dollars, put it to work in a responsible way and make out like a bandit? Or will it spend it all on hookers and blow and leave our grandkids in the hole struggling to pay off the principle?

Footnote: The answer to this question is usually along ideological lines. Keynsian economists like Paul Krugman who dominate the Democratic party will say Hell Yes! Government knows best and should borrow like there’s no tomorrow. Hayekian economists like Russ Roberts and economic conservatives on the other hand will tell you that the private sector knows best, government should limit it’s size and balance sheet and should never engage in massive borrowing no matter how low the interest rate or the potential return on investment, because it’s not government’s place to act like an investment bank.

Footnote2: I’m still feeling pretty good about my bull market prediction yesterday and am now long Apple (AAPL). I’m expecting it to churn during the next 6 months and have a 18 to 24 month price target of $550 (bought at $418).

Bull On.

Posted on January 5, 2012 by mark

I am long the stock market. I’ve been accumulating stock in businesses I understand for the last month or two. Why? I’m predicting a bull market starting in the next 12 months.

My reason for writing this is purely selfish. I want to be able to say I told you so. I’ve also been predicting armageddon for the last 10 years in the USA and it’s getting boring.

Here’s why a bull market is imminent:

We’ve so far dealt with a crisis in housing, money markets, mortgage backed securities, credit default swaps, commercial real-estate, municipal bonds, hedge funds collapsing due to over-exposure, the collapse of many small banks and collapse or almost-collapse of many larger ones, the risk of the FDIC running out of cash, our own country’s budget crises, legislative deadlock and sovereign debt crises both in the USA and Europe.
We’ve shone sunlight on all financial crises and there appears to be nothing coming down the pipeline except the latest report that China isn’t going to grow as fast as it was. Oh poo. Hell, the municipal bond crisis in the USA turned out to be the best performing fixed income investment in 2011 returning over 10%. Turns out local governments managed to cut costs, increase revenue and actually pay their debts.
American consumers have been paying down debt since 2008 and are flush with cash.
The DOW has been flat for 10 years. If you invested in the DOW 10 years ago your money is now worth 20% to 30% less in inflation adjusted terms.
Housing has flattened out and even Schiller is beginning to sound mildly optimistic that house values will start heading up within 12 months.
In real terms (inflation adjusted terms) housing isn’t down 30%, it’s down more like 45%. There isn’t anywhere else to go.
US corporations are more profitable than they’ve ever been and are priced attractively by any measure: P/E, P/S, Price/Book, etc. Companies like Intel are getting so frustrated at the crappy valuations they’re getting that they’re borrowing money to buy back their own stock and are paying 3% on debt rather than a 4% to 5% dividend yield.
Europe doesn’t really matter and isn’t that bad. To use a recent example from James Altucher, Greece to the European economy is like Rhode Island to the USA. It just doesn’t matter.
Unemployment is 8.5%. During the great depression it was 25% so enough with this “things are so bad” bull. Even if you assume 16% real unemployment if you factor in those that have stopped looking for work, it’s still nowhere near great depression levels.
Besides reducing our debt, everyone I know has been living frugally and actually accumulating cash.

When I say I’m long the market, I’m long specific stocks that are awesome businesses, have growth potential, have a monopolistic like advantage that makes them very hard to compete against. Two examples:

Intel (INTC): Basically they have a monopoly on server CPU’s world wide. I’m betting that the massive growth in data centers world-wide is going to continue to drive record revenue at Intel. The machine you’re reading this on has a 90% chance of having an Intel CPU inside. More importantly, the data center that served this page is full of Intel CPU’s and it keeps growing.
Amazon (AMZN): I love Jeff Bezos. There, I said it. He almost literally gives investors the finger and just puts his head down and keeps growing. Amazon’s revenue growth in the last 10 years has been stellar and consistent. Bezos is investing heavily for the future, including building his own platform and app store to compete with Apple and Google and continuing to expand warehouse capacity. The business is also wonderfully diversified into retail, cloud services and digital media. AMZN is valued using Price/Sales since it doesn’t have net income to speak of or dividend yield, and in historical terms the P/S is low right now.
Apple (AAPL): So I was avoiding this stock just because there’s way too much hype around it, but turns out it’s undervalued in historical terms. Check out AAPL’s P/E for example. Also check out Apples market cap relative to Microsoft’s peak market cap in late 99 early 2000′s. If Apple is truly the next big platform, it’s cheap when you adjust MSFT’s peak market cap for inflation.

Other businesses I’m interested in: WalMart, Costco, Visa (although I don’t understand financial stocks so will probably avoid).

Keep in mind I’m taking a 18+ month view on these companies and to me a 10% annual return would be spectacular considering a 2 year CD will give you 1.2% if you’re lucky. I’m also comfortable losing the principle – I have a strong stomach for risk.

Disclosure: I’m currently long Intel and Amazon and will probably go long on Apple as soon as the current rally dies.

Unemployment is lower? Bull.

Posted on December 5, 2011 by mark

Last Friday and again today the DJIA got a nice bump from data showing unemployment has dropped from 9% to 8.6%. This number is known as U3 and only counts those actively looking for work. U4 is what the government should publish which counts U3 + those who have given up looking.

We “added 120,000 jobs in November” and have added over 100,000 jobs per month for the last 5 months.

I found the birth, death and marriage rate on the CDC website. For December 2009 we had 344,000 live births per month, 216,000 deaths per month and 138,000 marriages per month.

Our population is increasing by roughly 128,000 per month, which is 8000 more than the number of jobs we added. Looking at marriages per month gives you an indication of how many new couples are starting life and presumably expecting full employment. That’s 18,000 more than the maximum number of jobs we added per month in the last 5 months.

I don’t think we’re ever going to get the jobs we lost back because the financial crisis of 2008 was a trigger that caused companies that have become more efficient to cut a workforce that is no longer needed. That is why corporate revenue has not declined even though unemployment has increased. The grey marks the recession, click the graph to go to ycharts for a live version.

The only way to solve this is to bring our education syllabus up to date. The chinese have a few ideas how to do that: They’re cutting majors that produce unemployable graduates.

Watch the last 2 hours of trading live if you can

Posted on August 8, 2011 by mark

I have a sinking feeling there will be blood. Right now Dow is down 4.45%, S&P down 5.69%, Nasdaq down 5.7%, Gold up 3.87% and rising. The DAX closed down 5% and the worst drops happend towards end of trading, so I’m expecting the same for US markets.

Update: I hate to say I told you so. Ugh!

Tokyo markets open up 1%, guess they’re not too worried

Posted on July 31, 2011 by mark

The Nikkei just opened and is up 1% after a brutal week. Guess they’re confident the US is going to get it’s act together. They must not have heard Pelosi is thinking of backing out. Or maybe FT.com’s stats are delayed.

Revenue and Runway – Why every cent matters

Posted on November 10, 2009 by mark

A month ago on Techcrunch, Michael Arrington wrote about “Twitter’s Revenue Dilemma”: “Your valuation can actually go down once you turn on revenue.”.

“Turning on revenue” frames it as a binary thing. You’re either making money or you’re not. It completely disregards the most important variable in finance: Time.

With the tiniest trickle of revenue you can extend your runway infinitely. That means you never have to raise another cent and you even have money to fund your growth. Let’s take an example:

Say you’re a consumer web business. You have some growth and some traction. You close an angel round for $400k in Month 1. In month 2 you start spending it and your burn rate is $25k for salaries, office and hosting. It takes you 4 months to get the product into shape and launch.

In your first month of launch you make a meagre $500 bucks. And lets say you suck at marketing and your revenue increases by $1000 per month so that a year after you launch your product (17 months after getting funded) you’re making $12,500 per month in revenue.

Even two years after getting funded you’re still only making $19,500 which is far from breaking even.

But what this does it it slows your burn rate enough and buys you enough time so that you never run out of money. That means you can keep paying yourself a full salary and growing your business and you never run out of cash. In month 29 your bank balance drops down to $12,500, but then it starts increasing again because in Month 30 you break even.

If you didn’t generate any revenue in the first 18 months you run out of money in month 17.

You might argue this approach stifles growth. So be more aggressive, increase your burn rate to $200k and raise $3 Million. The same logic applies. Early cash-flow that is far from break-even can extend your runway to infinity (and beyond).

This matters for founders more than anyone else because it means you can raise a single round and never have to give away any of your equity ever again.

The sheet below shows the two scenarios – with and without revenue. [I've reoriented the flows vertically for readability]

Costs and Startups – Advice for your CFO

Posted on November 1, 2009 by mark

In any company if you save $1 it goes straight to your bottom line. Meaning it’s as if you just earned another $1. The company that my wife and I have been running for about 2 years now serves over 30 Million page requests per day. We’ve invested a lot of time in getting more performance out of our hardware but about 6 months ago we started hitting pesky issues like limits on the speed of light and electrons.

So we’ve had to keep growing without going out and buying a Google-size web cluster. A lot of the wins we’ve had have been simply using every spare drop of capacity we can find. I’ve noticed a pattern during the last 6 months. It goes something like this:

Kerry (My wife, our CFO, and keeper of the graphs): Server 12 is hitting 10. [Meaning it has a load average of 10 on an 8 CPU machine which is 125% load]

Me: OK Dell has this great special on these new R410 servers that are about twice as fast as the previous generation.

Kerry: What about the other machines in the cluster?

Me: They’re already at 80%.

Kerry: OK what else do we have?

Me: Well the crawlers are maxed, the mail server’s maxed, the proxy’s maxed out, the load balancer is maxed….

Kerry: What about 25 and 26? They’re sitting at 2.

Me: Well we’d have to [technical and managerial speak explaining how complicated it's going to be to implement]

Kerry: OK so lets do that.

Me: [More bullcrap this time rolling out the big guns desperately trying to get money for new toys]

Kerry: …[waits it out]

Me: OK so lets do that.

If you’re a CFO approving purchase decisions in your company, take it from me: Geeks and CEO’s alike love buying new stuff. I assure you there isn’t a web cluster or database cluster on this planet that you can’t squeeze a little more capacity out of without breaking things. So before you take the [technical and managerial bullcrap from your geeks and CEO] at face value, sit down with your team and have them explain all the data to you and go through all your resources with a fine tooth comb. Then, if you absolutely have to, spend some money.

And if you don’t have a CFO, nominate someone immediately!! It doesn’t matter how small you are, someone had better be the keeper of the cash-flow plan or you’re going to run out of money and wonder why.

Incidentally, this is the load decrease on one of the busiest servers in our cluster when we brought online some ‘found’ capacity earlier today.

Posted on Hacker News.

The DOW 10K priced as opportunity cost

Posted on October 17, 2009 by mark

Economists love the concept of opportunity cost because it gives you a the real long-term value of an investment or purchase in relative terms – which is really the only way to calculate value. On Wednesday the DOW hit 10,000 again. The US financial press did their part to ring the bell while the banking community celebrated the boost in perceived value and the increased likelihood that the public would buy their wares.

Fox News, like clockwork, has given former asshole president Bush credit for the recovery. (Skip to 3:00 in the video) “He took the bold moves and look where we are today..”.

John Authers in the Finanial Times is almost embarrassed on Thursday as he delivers the news of what a DOW 10K means in real, opportunity cost terms. If you invested in the DOW in 1999:

Relative to emerging markets you’ve lost 80% of your money.
Relative to gold you’ve lost 75% of your money.
And even in dollar terms corrected for inflation (using the CPI) you’ve lost around 23% of your money.

Great interview with Columbia’s Bruce Greenwald on value investing

Posted on October 11, 2009 by mark

There’s a spectacular interview on ft.com today with my favorite FT journalist John Authers with Bruce Greenwald who teaches Ben Graham’s value investing course at Columbia.

Bruce talks about behavioural finance and the irrationality of investors, the often ignored mathematical realities of the market, the brutality and danger of short selling (all short sales are treated as short term capital gains), the power and value of franchise and much more!

I love his constant reminder of what value actually means: First look at the balance sheet, then current earnings ignoring growth.

He does a great fast analysis of why even value investors got caught with Fannie and Freddie because they misanalysed the balance sheet.