Ken Kam's Best Ideas Blog

Mark Twain once said that its not what you know that gets you in trouble, its what you think you know for sure that ain’t so. In my experience, when it comes to investing, Mark Twain was absolutely right. I’ve spent a lot of time trying to unlearn things I was sure of that just ain’t so.

Recently I ran across an article that repeated a story that concludes that you cannot tell anything about an investor's future performance from his past track record. I first heard this story over 20 years ago, and to tell the truth, I was once so convinced by it that for a good part of my youth I kept my core equity portfolio almost entirely in index funds.

The author of the article asked readers to imagine a stadium full of people ready to flip a coin. After each coin-toss, those who throw tails are asked to leave. At the end of 10 coin-tosses, there is one person left who has the exceptional track record of throwing heads 10 times in a row. Now, the author asks, would you bet on this person to do better than average in the next 10 coin-tosses? Of course not.

Continue reading (with subscription) "Learning from Mark Twain" »

Posted by Ken Kam at 08:42 PM | Permalink

In the last three months, I’ve come to the conclusion that the credit crunch is one of those rare events that is significant enough to change our long-term outlook and investment strategy.  Here’s why.

Banks used to give loans only to people they believed would pay them back. This was the business model of every bank -- until the securitized loan business invented a new school of go-go banking.

It's that business that has broken down.

For banks, the securitized loan business model offered two big advantages. Since the loans were packaged and sold to investors, the quantity of loans a bank could make was not limited by its capital. And the bank was off the hook if a loan wasn’t repaid.

The profits generated from securitizing loans made a big contribution to earnings growth in the financial sector. And therein lies the problem for stocks. The shutdown of the securitized loan industry is going to take a big chunk out of the earnings of Washington Mutual (W),  Citibank (C), Merrill Lynch (MER), Bear Stearns (BSC) and other names that were the leaders in securitizing loans.

Investors might be able to look past the big subprime mortgage write-offs if they believed the banks’ problems were behind them, because in the end, market prices reflect future earnings. But without a source of earnings to replace the profits that used to come from securitizing loans, it will be difficult for the financial sector to sustain a rally.

So although the financials have taken a beating, I am not at all tempted to bottom-fish the sector because I don’t see how earnings can recover. Further interest-rate cuts will not restore the securitized loan industry, so if earnings are to recover, they are going to have to come from something else that I don’t see right now.

Continue reading (with subscription) "The banks aren't bouncing right back" »

Posted by Ken Kam at 02:46 PM | Permalink