Monthly Archives: April 2015

Martemucci vs. Alexander

OK, that title is an exaggeration.  But they have recently presented vastly differing viewpoints on the dangers our nation faces via cyber attacks.

Col. Mateo Martemucci, USAF, soon to join the Joint Chiefs in DC, is our top military guy in cybersecurity.  He spoke April 29, 2015, to CFA Pittsburgh (FB) at the Duquesne Club.

He began by defining the internet of things – it includes anything with an IP address, meaning not only your phone, but also your smart thermostat, cars, etc.  Then he defined the levels of mischief:  Cyber attack (4DM – Defeat, Deny, Diminish, Destroy), Exploit (to copy and steal information, like account information), and Espionage (which may be attack or exploit or both).

The three kinds of attacks are Information, which is propaganda and denial of service, Infrastructure, and Economic Infrastructure.

The sources of the attacks are the internet (outside), supply chain (the hardware or software as purchased on the computers you use), and Insiders, which is the hardest to control.

The bad guys are nation-states, NGOs (like terrorist groups), and individuals (hacktivists).

He stated that there are currently no disincentives to this hacking.  But I think the people he talked about who have been arrested for it would disagree.  However, this is largely true for people outside the US, as well as nations and companies.

Colonel Martemucci concluded with his opinion that economic espionage is the SINGLE GREATEST THREAT to our national security.

He noted that the military currently has no legal standing to defend any website, IP address, company, or person against cyber attack from within or outside the US, and that it would take legislation for them to be able to act in that realm, other than .mil and .gov.  He also compared the situation to the Barbary Wars, which was the impetus for the formation of the US Navy and Marines in their current form.  At the same time, he stated “the less we give the government to do, the better.”  His opinion is that we should defend at the lowest possible level, with public private partnerships as appropriate.

In contrast, former NSA chief Keith Alexander was recently interviewed by Ambrose Evans-Prichard of the Telegraph.

“The greatest risk is a catastrophic attack on the energy infrastructure. We are not prepared for that,” said General Keith Alexander, who has led the US battle against cyber-threats for much of the last decade.

Gen Alexander said the “doomsday” scenario for the West is a hi-tech blitz on refineries, power stations, and the electric grid, perhaps accompanied by a paralysing blow to the payments nexus of the major banks.

“We need something like an integrated air-defence system for the whole energy sector,” he said, speaking at a private dinner held by IHS CERAWeek in Texas.

More insidiously, there is now a systematic effort by state-backed hacking teams to steal technology from Western companies. “This is the biggest wealth transfer in history,” he said.

Gen Alexander, who served as head of US Cyber Command as well as director of the electronic eavesdropping agency, listed five countries able to conduct cyber-warfare at the highest level: the US, UK, Israel, Russia, and surprisingly Iran.

He did not include North Korea, describing the cyber-sabotage of Sony last year as relatively primitive. The attack could have been prevented with early warning sensors that pick up changes in the “behaviour” of computer systems.

China clearly has first-rate hackers, allegedly concentrated at a 2,000-strong cell of the People’s Liberation Army in Shanghai. The current NSA chief Michael Rogers testified late last year that China is capable of cyber-attacks that could cause “catastrophic failures” of the water system or the electricity grid.

There is no suggestion that China has an intention to use its power to damage US infrastructure. NSA officials are less confident that Iran will show self-restraint.

The Iranians revealed their skill in August 2012 with a taunting virus attack on Saudi Aramco, Saudi Arabia’s state-owned oil giant. Hackers erased most of the company’s emails and documents, leaving an image of a burning American flag on the computer system as their calling card. There was a similar attack on Qatar’s state-energy group RasGas.

The action was a form or retaliation for economic sanctions against Iran, but also a warning shot to Riyadh in an escalating battle for Mid-East dominance by the two regional superpowers. It is highly pertinent today given comments by leading figures in Tehran that the Saudis will be “punished” for their decision to drive down the price of oil.

A report by the cybersecurity firm Cylance Corp claimed that Iran’s experts have hacked into the email systems of the US navy and marines, as well as other critical computer systems in Britain, France, and Germany.

The American Enterprise Institute has issued its own report concluding that the nuclear deal with Iran will merely enable the country to step up its step up its attacks. “It would be comforting to imagine that a new era of détente will end this cyber arms race. There is, unfortunately, no reason to believe that that will be the case,” it said.

Interesting.  Colonel Martemucci stated that he is not at all concerned about any nation-state attacking infrastructure, because our economies are now so interconnected that if the US East Coast was shut down, it would cause a great deal of economic pain world wide, including the source of the attack.  I think this is certainly true for China, and as sanctions are lifted, the incentives for Iran would all be on the side of NOT attacking, as they integrated back into the world economy.  Also, you can’t sell oil if all the gas stations are shut down!  This is a disincentive even for Daesh.

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Listeria in Blue Bell ice cream

This is really inexcusable on the part of Blue Bell:

Blue Bell, which is based in Texas, said it recalled the products after two half-gallon containers of chocolate chip cookie dough ice cream, produced on March 17 and 27, tested positive for the bacteria Listeria monocytogenes.

Five people in Kansas appear to have been sickened from January 2014 through January 2015 while they were hospitalized for unrelated conditions, the C.D.C. said. Of the five, four are known to have had milkshakes at the hospital made with a Blue Bell ice cream called Scoops and two other products made at Blue Bell’s plant in Brenham, Tex.

The Texas patients also developed listeriosis, the condition of being sickened by listeria, after being hospitalized for unrelated reasons from 2011 through 2014. Tests on the genome of the strains with which they were infected “were nearly identical” to strains found at Blue Bell’s plant in Broken Bow, Okla., the C.D.C. said.

Tests are being conducted to see whether three other patients infected with listeriosis between 2010 and 2012 were related to the Blue Bell outbreak, the C.D.C. said.

Blue Bell began removing ice cream products from the market on March 13 after the health authorities reported that they suspected a connection between the Kansas infections and products made by Blue Bell’s Texas plant, the Food and Drug Administration said.

So, people started getting sick in 2011.  It was connected to products from a specific plant starting last year, and they just now, last month, March 2015, found the bacteria in 2 (!!) cartons of product from that plant, and a second plant has also been implicated through genetic testing.  That last part is a little vague, as to how they connected the strain of bacteria to the Oklahoma plant.

If you have worked in food manufacturing, you know how ridiculous this is.  It’s complete negligence on the part of management.  You can test product, as well as surfaces in the production facility, for this bacteria.  They should have found it and eliminated it as soon as there was a suspicion.

There should be some consequence for this.  I would start with criminal charges for upper management.

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WalMart >>>> Satan

More proof that Wal-Mart is not the devil.

ThinkProgress reports on the company’s initiative to reduce use of fertilizer.  They stress how the free market is now taking over functions that used to be performed by the government:

Daniel Glickman, former Secretary of Agriculture who also spoke on the panel at the National Food Policy Conference, agreed with Festa that Congress’ role in driving food policy might be waning. “More and more, farm policy is going to be done by other people,” he said, “by Wal-Marts, retailers, and cooperatives.”

When Glickman was Secretary of Agriculture, he remembered, conversations about farming in the United States were dominated by commodity crops and a singular focus on productivity. Today, he says, that’s beginning to change.

“There are more and more people interested in diversity of food, local food, organic food,” he said. “We’re going to be less dependent on what the national government does every five years.”

This is a bonus that we get from our dysfunctional government.  They have not been able to regulate fertilizer use, or come up with any agreement on any environmental or climate related anything, but they also have not been able to legislate it OUT of the hands of private companies.

So Wal-Mart will now force its suppliers to reduce fertilizer use.  Note, this is a big win for the company in terms of dollars – they will undoubtedly require a price cut equal to a large percentage of the cost of the fertilizer that will be saved.  They get money, AND they get to look like the good guys.  And maybe they are actually being the good guys.

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Mebane Faber

Yesterday 4/15/2015 (Yay! tax day!) Mebane Faber spoke at the CFA Society Pittsburgh.  Love those Duquesne Club macaroons.

His presentation was about investing on a global scale and the use of value metrics.  He also touched on cap weighting vs. pretty much any other weighting scheme.  He mentioned Rob Arnott but not his monkeys.

Meb was very friendly and answered questions during the presentation and afterwards, thanks!  Even my dumb one.  I just don’t think like a stock picker (that is not intended as an insult in any way, to anyone).

One point he made was that home bias leads to over investment in US markets for US investors, and that this has been a winner in the past, but that value metrics suggest that this may not be true going forward.  I think he is correct, but this emotional investing (which he also talked about with those excellent bull/bear graphs) is also what leads to the cap weighting bias.  Well, that and cost.

One of the issues that has been huge for advisors during the time of US equity outperformance is that it’s really hard to sell clients on global investment when the rest of the world looks like crap compared to US.  This is really career risk, and it’s a communication issue for the advisor.

In the same way, other-than-cap weighting, or what the industry typically calls “smart beta,” comes with some career risk.  I think everyone acknowledges the fact that cap weighting causes you to hold too much of overvalued stocks, and not enough of undervalued stocks.  Well, not everyone.  There are still a few people who cling to EMH despite all the overwhelming evidence of its imperfections.  Anyway, the problem is that the advisor has to select and then defend an alternative.  In addition, this alternative costs more than the cap weighted funds (which are at .10% and below now!  Wow!).  I like Rob Arnott’s RAFI indexes (currently priced at .39%).  They are not based on any kind of “tilt,” but are purely an attempt to weight equities by some size measure that does not include price.  But the track record has to be looked at over the long term in order to see a benefit in performance.  Which makes sense in a bull market – prices are going up for almost all stocks, and as they go up, the more winners you hold, the richer you get.  Here’s data from the Invesco website:

as of 03/31/2015
YTD
1 Year
3 Year
5 Year
10 Year
Fund Inception
Index History (%)
FTSE RAFI US 1000 Index 0.32 10.24 17.29 14.64 N/A 9.13
Russell 1000 Index 1.59 12.73 16.45 14.73 8.34 7.99

So you can see that some up and down is required for the smart beta to look very smart.  This past 3 years have been really rough for the international smart beta advisor.  2011 had a small drawdown, which may explain the 5 year beat by RAFI.

Mr. Faber also showed a John Hussman chart.  Love that guy, although THE SKY IS FALLING!!

Informative presentation, although, since I have already read most of his stuff, there wasn’t much new for me.  It’s nice to meet one of your most admired investment thinkers in person.

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California Drought

I don’t understand water use and public policy in California.

They are, by all accounts, in a severe drought that is not expected to lessen, and may become the new normal, see US Drought Monitor, NOAA:

United States Drought Monitor/NOAA

It seems like a relatively simple task that must be completed.  Not easy, but simple.  The state needs to ensure that water use is equitably priced across the state, or at least across areas of drought (which is pretty much the entire state anyway).  Equitably, meaning that all water use carries a price, and that price is not much different regardless of the water source or the end use.  “Not much different” would have to be determined by, most likely, the state.  In addition, water use, for instance, from private wells, would have to somehow be determined.  The underground aquifers that private wells tap are, at this point, a vital public resource.  This is kind of a definitional reason to have government at all.

It’s unclear that anything remotely like this is being considered at this point.  Here’s how water is actually used in California, info from Public Policy Institute of California:

wateruse2-full

So, if you exclude environmental water use, “Urban,” which includes all the landscaping, is about 20% of the remaining water use, and Agriculture is the other 80%.

And yet, here’s what the governor is doing, as of April 1:

Save Water

For the first time in state history, the Governor has directed the State Water Resources Control Board to implement mandatory water reductions in cities and towns across California to reduce water usage by 25 percent. This savings amounts to approximately 1.5 million acre-feet of water over the next nine months, or nearly as much as is currently in Lake Oroville.

To save more water now, the order will also:

-Replace 50 million square feet of lawns throughout the state with drought tolerant landscaping in partnership with local governments;
-Direct the creation of a temporary, statewide consumer rebate program to replace old appliances with more water and energy efficient models;
-Require campuses, golf courses, cemeteries and other large landscapes to make significant cuts in water use; and
-Prohibit new homes and developments from irrigating with potable water unless water-efficient drip irrigation systems are used, and ban watering of ornamental grass on public street medians.

Increase Enforcement

The Governor’s order calls on local water agencies to adjust their rate structures to implement conservation pricing, recognized as an effective way to realize water reductions and discourage water waste.

Agricultural water users – which have borne much of the brunt of the drought to date, with hundreds of thousands of fallowed acres, significantly reduced water allocations and thousands of farmworkers laid off – will be required to report more water use information to state regulators, increasing the state’s ability to enforce against illegal diversions and waste and unreasonable use of water under today’s order. Additionally, the Governor’s action strengthens standards for Agricultural Water Management Plans submitted by large agriculture water districts and requires small agriculture water districts to develop similar plans. These plans will help ensure that agricultural communities are prepared in case the drought extends into 2016.

So, they are going to ask the users of 20% to reduce by 25% of that, saving 5% of the total.  And they are going to ask the users of 80% to please try to make some reports about their water usage?  I can see how a third generation dairy farmer, using his own wells, would find the imposition of taxes or fines around water usage to be an outrageous encroachment of state authority on his freedom.   Same with the almond farmer, watering her well established trees.

The least unfair way to allocate water is going to be with a market for the water.

 

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Theory of XT

Ric Edelman is a highly successful investment advisor.  He decided that there was not a simple way to invest in what he calls “Exponential Technologies,” so he made his own ETF, and funded it through his firm to the tune of $560M, which made it news.

I have a bunch of questions about whether or not this is a good idea, and looking at the fund fact sheet helps with some of those answers.

    • Isn’t this all in the “technology” sector?  No.  He is trying to include disruptive technologies in pretty much all sectors.  This includes biotech companies trying to re-invent treatment of diseases, solar and other energy companies trying to disrupt the fossil fuel – utility model, and other companies that he feels are actively working on a disruptive technology or model.
    • Looking for exponential growth of the technology, therefore the stock.  Why can’t you just buy a small cap fund and call it a day?  I think that he must have analysts diving deep into filings, looking at R&D as well as forward guidance talking points.  He’s got Airbus, T-Mobile, Netflix, and Amazon in his top 20 holdings.  These are not small caps, but he must feel they have some technological competitive advantage. BTW, this is a somewhat global fund, including emerging markets.  How many analysts are working on this?  That’s a big universe of stocks.  Pretty much all of them.

 

      How does one select these stocks?  And weight them?  This is a red flag for me.  Here’s how the index is described:  “The iShares Exponential Technologies ETF seeks to track the investment results of an index composed of developed and emerging market companies that create or use exponential technologies.”  That sounds like a mutual fund or stock picking theme, not a rules based index that you can replicate at home.  In an interview with ETF.com, Edelman put it this way:

 

Morningstar thought it was a great idea and agreed to create the index, which contains, as you know, 200 securities, equally weighted, with a very robust indexing process that is Morningstar’s expertise.

  • Here’s the index page.  AHA!  It’s picked by committee.  You can’t replicate it at home.  The process reads like how you would select a capital project, or run a model UN meeting:
  • Step 1: Managers from Morningstar’s global Equity Research team identify technology themes with the potential to have significant economic benefits to producers and users. As of September 30, 2014, nine current themes have been identified:
    Big Data and Analytics
    Nanotechnology

    Medicine and Neuroscience

    Networks and Computer Systems
    Energy and Environmental Systems
    Robotics
    3-D Printing
    Bioinformatics
    Financial-Services Innovation
    Step 2: Morningstar’s Equity Research managers train analysts on the themes and scoring framework. The analysts then score the companies in Morningstar’s global coverage from 0-2 on each theme.
    No or little exposure: 0
    Moderate exposure: 1
    Significant exposure: 2
    Step 3: Managers in the Equity Research team calibrate scores across individual analysts, sectors, and themes. Managers review the scores of 2 across each theme and collectively select ”leaders” (whose scores are increased
    to 3 from 2). Leaders are defined as firms expected to have significantly more exposure than other firms that scored 2. Each theme may have between one and five leaders.
    Step 4: Exponential technology scores and theme leaders are reviewed annually by the Equity Research team before each reconstitution of the index.
  • Sheesh.  Oh, and the analysts are the entire Morningstar team.  So, I think this has a lot of baked in career risk.  Which is exactly the opposite of what you want in this kind of fund.  Since the fund is looking for only a specified list of breakthrough technologies, an actual brand-spanking-new breakthrough is, by definition, going to be excluded.  Are self-driving cars in there?  Maybe.  That list of 9 “themes” is a mess.  Some of them are specific technologies or uses of specific technologies (3D printing), and others are just areas where they think new technologies can best be applied.

Important note:  The entirety of the renewable energy business is split between Information Technology (inexplicably, as Semiconductors & Semiconductor Equipment,) and Utilities.  Energy sector in GICS is defined as and and exclusively comprised of fossil fuel businesses.  That’s why Energy is such a small (2.3%) part of the portfolio.

I understand why Mr. Edelman, and presumably everyone else, wants to own the companies that are coming up with breakthrough technologies and bringing them to market profitably.  However, I think just reading that last sentence reveals why that’s not as simple as buying an ETF of 199 hand picked companies from around the world.  Maybe some of these are going to break out and become the next Apple or Tesla (both of which, by the way, are in the fund).  But I suspect the fund will miss as many (or, being more optimistic, nearly as many) as it catches.  That’s why you buy the market, because you aren’t confident in your crystal ball gazing abilities.  Or that of your Morningstar committee.

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Polio vs. Cancer

Highlights of 60 Minutes work, via Seeking Alpha:

  • Last night on CBS’ 60 Minutes news show, two segments were dedicated to an experimental treatment for brain cancer being developed at Duke University. The therapy, based on a genetically modified form of the polio virus, was injected directly into the brains of patients with glioblastoma, a type of brain cancer with a poor prognosis. Of the 22 patients treated in a Phase 1 study, 11 died. In the group of 11 survivors, though, all experienced a shrinkage in their tumors with three being cancer-free.
  • The polio virus, engineered to render it incapable of harming normal cells, replicates in cancer cells, killing them. Other viruses under investigation as cancer killers are herpes simplex, vaccinia and respiratory viruses.
  • The unique feature of engineered viruses is that they are designed as a single treatment, rather than a multi-dose regimen. Another benefit is their scalability, a potential problem with personalized CAR-T therapies.

 

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