Economic turbulence ahead for 2006?

Normally in the fixed income market, there is a direct relationship between the length of an asset’s term to maturity and the yield from that asset. For example, the yield on a 30-year bond should be higher than that on a 10-year bond, and that on a 10-year bond should be higher than that on a two-year note, and so on and so fourth. Any deviation from this is results in an inverted yield curve.

 

An inverted yield curve is an MBA student’s worst nightmare because historically it has been a reliable indicator of bad economic times ahead. This happened in November for the first time since 2000 and happened again earlier this week. Only twice in the past 50 years has the inverted yield curve not been followed by a downturn in the economy. The most recent occurrence was in 1998 when there was a financial crisis in Russia and Long-Term Capital Management had just gone out of business. Investors in droves moved their money into bonds, thus raising bond prices and lowering bond yields.

 

I have heard stories from alums that graduated from Kenan-Flagler a few years back about how bleak the job market was when they graduated. I personally hope any downturn in the economy won’t happen until at least the fall when by then, I have hopefully secured my full time post graduation job offer.

Quizzing the Sage of Omaha

Without a doubt the highlight of Mod II has been the trip in November to see Warren Buffett in Omaha. It was a great opportunity to see how his mind works to logically analyze business (and other types of) situations. I know from emails I have received due to the blog that Buffett has a large following in the blogosphere and no doubt this posting will receive a bit of attention. I therefore wish to make the disclaimer that while every attempt will be made to present an accurate portrayal of what he said on November 14th, this blog posting is by no means an official record of what he said to us.

One of the first questions asked was about good parenting. Buffett said parents’ verbal message should be consistent with their behavior. He also talked about what he values in life. He said “if you tell me who your heroes are, I can tell you how you will turn out in life. Life is not played with a rewind button, there is only a play button.” He also said one cannot decide whether one can kick a football 70 yards or dance like Fred Astaire, but can only make decisions over other matters such as whether to be generous and to be kind.

A vice that Buffett repeated warned against is greed. He said “I don’t fool around on borrowed money. I have always been happy with what I have. I don’t live any differently than I did 40 years ago, same house, same office.” He said “I think people get greedy because they think they can be happier if they have more money and can buy more things.”

Buffett talked about what types of businesses he likes. He said the worst kind of businesses to be in is the type that requires the owner to keep putting more and more money into the enterprise. He talked about his 1989 investment in U.S. Air as an example of this type of business, “as the ink was drying on the check, my money was gone.” He jokingly said he has an 800 number that he calls every time he gets the urge to buy an airline.

He talked about his investment this past summer in Forest River, a manufacturer of recreational vehicles. His negotiations began in June when he received a one and a half page fax from its owner Peter J. Liegl. When he met with Liegl, he was exactly as he had anticipated. After the deal was made Buffett wanted to hire Liegl to run the business, he asked Liegl what salary he wanted and the reply was “I don’t want to make any more than you do.” He said he tends to hire the person that sold him the business to run it. He also looks for people that like the business rather than those out for themselves or out to make money.

Buffett looks for businesses with an enduring competitive advantage that will remain relatively unchanged in the future. He gave Coca-Cola as an example of a business with such a trait. He wants the brand to be associated with happiness, and with institutions such as Disneyworld and the Olympics. He jokingly said he wants to give out Pepsi at funerals. Gillette is also another brand with an enduring competitive advantage. He likes to measure a business by whether a competitor with deep pockets can influence the market. “I can give you $5 billion and you cannot take the business from Gillette.” Another reason he likes Gillette is he can understand how the business will be like 5, 10, 15 years into the future. He said the Internets will not change the shaving business and he has no reason to believe management will change. He talked about his 2001 purchase of custom frame manufacturer Albecca, which he described as “a business with a moat around it.” He then added “I cannot tell you what Intel will be like 10 years from now but I know what this business will be like.”

Someone pointed out the extra cash his company is holding and asked whether he intends to pay a dividend to Berkshire Hathaway shareholders. He said he will consider such a move only if there is nothing intelligent to do with the money within a reasonable time. “Our experience has been that you do find things but not everyday.” His experience has been that the worst time to find value in the market is when everyone else is excited about the market. He gave the example that on the day NASDAQ hit its all time high was the same day Berkshire Hathaway stock hit its all time low. He pointed out that there is an “unusual corollary” involved with a possible dividend because heowns a large stake in Berkshire Hathaway and therefore a significant percentage of any dividend will go back to him and he would have to look for ways to invest it.” He said he wanted his company to keep at least $10 billion in cash because of the insurance business. He wants to be prepared for the “hurricane that makes Katrina look like a warm up act” and for the possibility a nuclear bomb detonation will prevent the stock markets from opening. He then said something which implied that he believes most insurance companies are not prepared enough for such possibilities by not sitting on enough cash and planning to rely on lines of credit to pay out policy holders.

His comments on inflation were “I always feel inflation is in remission, you can’t get rid of it.” He said one “guarantee” about risk is that it is not measured by beta. His definition of risk is it is incurred when you exit your circle of competence. He believes the only two courses you will ever need for investment management are one on how to value a business and another on how to think about the stock market. He recommends that we all get into the habit of walking around our neighborhoods and trying to understand the local business and the logistics behind them.

He believes that much of his wealth is attributed to luck and that he’s benefited from having been born a white man. He said society, along with geography and timing have contributed. He believes there is an advantage to being born in the United States but that advantage is not as big as it was 50 years ago. He defines wealth as “a claim on future goods and services” and said he does not believe that being born into a wealthy family should entitle one to claims on others’ goods and services.

Later on that week I met a recent Kenan-Flagler alum at a recruiting event for a major Wall Street firm. When I mentioned the trip to see Buffett he said if he had known about it, he would have taken time off from work to go with us. Getting the chance to meet Warren Buffett was truly a remarkable experience.

New year’s present from the state government in Raleigh

And it’s a present that keeps on giving, or in this case, taxing. Starting January 1st, the state gas tax will increase by 15 percent, increasing gas price by 2.8 cents per gallon

                         

Some of you Kenan-Flagler folks who are traveling outside North Carolina may want to fill up your gas tanks before returning.

“Previously, on the West Wing”

After my operations final on Saturday, I had the chance to catch up on the latest episode of the West Wing. Even though the show is not nearly as good as it was before, I am still a fan and it’s the only show my VCR is programmed to tape regularly. The episode was particularly memorable because less than 24 hours ago, John Spencer had passed away.

There was one line from the show I really liked. It came from John Spencer’s character, who was running for Vice President of the United States, talking to his campaign manager Josh Lyman. The campaign was not going as expected and Josh was about to be fired for having made a string of bad decisions.

“These are tough calls, it's impossible to know how they are going to turn out, what’s important is how you respond when you get it wrong, how you react, what your next move is.”

Mod II goes into the history books

The hardest part of MBA curriculum at Kenan-Flagler came to a close yesterday when I completed my macroeconomics final. Last night we had another end of Mod party at the Martini Bar on Franklin Street. The $450 tab set up by the MBA Student Association ran out about half an hour after the event started. 

 

While I am glad that Mod II is over, I am keenly aware that Mod III presents new challenges. Immediately after I finished my exam yesterday, I received an email from the Office of Career Services informing me that one of the companies that I had dropped my cover letter and resume for had pre-selected its list of students it wishes to interview and I am not on it. While I certainly did not expect to be on the ‘closed list” for all the companies I had “dropped” for, getting the email was a sober reminder of what I have to worry about for a good part of Mod III.

Time-Out after strategery

The strategery final this morning was pretty much what I had expected. We had to apply the frameworks from the class on scenarios involving joint ventures, mergers and acquisitions, and entering and exiting an industry. The exam was closed book but we were allowed to bring in a “cheat sheet” with our notes from the class. Many students brought the same “cheat sheet” into the exam, the same one that was passed to us from the second years, the same one that no doubt we will pass onto next year’s students. There was one question that threw people off. It had to do with firm competitive advantage. He used a term that was covered in class but not mentioned on the “cheat sheet” and a lot of students had trouble answering it. I would not be surprised if I get a 0 out of the 15 points allocated for that problem.

After the exam, I had lunch with some classmates at a place on West Franklin Street called Time-Out. It came highly recommended from another classmate who attended UNC undergrad, one whom I suspect reads this blog. The cashier was a jovial fellow who kidded around with customers waiting in line. When he rang up my order of broiled chicken, French fries, and potato salad and I gave him exact change, he said “you’re a gentleman and a scholar.” My response was “not after today’s exam I am not.”

“Functional psychopaths” make the best traders and investors

"In a study of investors’ behavior 41 people with normal IQs were asked to play a simple investment game. Fifteen of the group had suffered lesions on the areas of the brain that affect emotions.

The result was those with brain damage outperformed those without.

The scientists found emotions led some of the group to avoid risks even when the potential benefits far outweighed the losses, a phenomenon known as myopic loss aversion." - Reuters article

I am tempted to crack a joke about my classmates that are looking to go into sales and trading or investment management. But I won't.

That was a hard one

Unfortunately I am not talking about the punchline to some dirty joke you may have heard in high school. I am talking about this morning’s operations final.

                         

Operations is the hardest class this Mod. Many alumni I meet remember it as one of the more challenging classes. To those of you who are not familiar with MBA classes, operations is a class that answers the question “how do you run a business as efficiently and profitably as you can?”  This means how to maximize the capacity of a restaurant and its subset operations (ie the bar, the waiting and dining rooms), the efficiency of a company’s supply chain, or the profits of the local newsvendor (also known as the classic newsvendor problem).

I like the class a lot but find the material to be next to impossible to understand. I heard someone say that last year’s final exam had a 40% average. We were given gave us last year’s exam to study from. I thought today’s exam was much harder. I noticed that it had a total of 180 points and since we had three hours to do the exam, that translates into an average of one minute per point. I am hoping that this exam’s outcome will be similar to that of last Mod’s analytical tools exam. I thought the test was impossible but ended up getting a score slightly above the mean because everybody else did just as poorly as I did.

Close call in finance

During Mod I there were a couple of times when I showed up to class late because I had overslept. I eventually began using a backup alarm clock. The system has worked well and not once did I oversleep during Mod II, that was until this morning.

 

I spent the entire day yesterday in McColl studying for finance and went home early to watch the Apprentice and to get a good night’s sleep before my exam. I neglected to set my alarm clock before I went to sleep and when I woke up, it was 8:35 and I had 25 minutes until my final exam.

 

By the time I got to McColl, it was already 8:55 and all the good seats in the rooms had been taken. I pulled up a chair (I purposely chose one with a writing surface) next to an AC outlet (I forgot to turn off my laptop last night and the battery was drained) and did the exam in the front of the room The questions were not any harder than the practice problem sets we had to do for class but it felt much harder because we had a time limit.

 

The professor that taught the first part of finance during Mod I used to encourage us to perform an “internal sanity check” on all our answers. One of those “internal sanity checks” saved me today. In one of the problems, we had to calculate the Rs (cost of levered equity capital) and the Ru (cost of unlevered equity capital). When I completed the problem, I noticed that my Ru was bigger than the Rs. This failed my “internal sanity check,” which tells me the weighted average cost of capital should always be lower than the Ru, and the Ru should always be lower than the Rs. Turns out while calculating the capital asset pricing model, I had plugged in the market risk premium as the market return.

 

I am hopeful I can get an H in finance. On three of the problems I am certain I got right. The other four contained so much detail I really had no way of ascertaining as to whether I got them completely right or not.

 

And in case you are wondering, my second alarm clock did not work this morning because I had tinkered with it yesterday. I noticed that it was five minutes behind and in my attempt to set the correct time, I turned off the alarm function.

Bob Grant to retire from radio

"After an on-air career that spanned more than 50-years and made him one of the most influential voices in political media, talk radio giant Bob Grant is leaving WOR Radio in New York." - NewMax.com article

This means nothing to about 99.9% of my regular readers but I just learned thirty minutes ago that the man I grew up listening to on the radio, Bob Grant, will do his last radio show January 13th. I dare say there is no one alive today (other than Jesus Christ) who has influenced me more than the man often referred to as “the King of Talk Radio.” In the past couple of years, I have not listened to him as much as I did when I was young but I still tune in to him (either on the Internets or in the winter time when the AM radio signal travels much further after the sun goes down) as often as I get.

I will blog more about this in a subsequent post.

Smoked the marketing final

The marketing final was much easier than I had expected. This goes to show that I tend to not just over-worry about things, but worry about things that are of relatively low importance. The marketing class this Mod has the most amount of reading, the reading material comprised of a textbook that I never open, and a thick binder that holds all the class slides, case readings, and articles.

 

Today is the perfect day to have this final because it was 24 degrees when I woke up this morning and I don’t expect the temperature to rise north of the freezing point anytime today. After dinner tonight I am going to put a log in the fireplace, get the fire going, and toss in all my marketing material. Oh wait, I can’t do that here because I don’t have a fireplace anymore.

Marketing the Xbox 360

About one week from now, almost to the exact minute, I should be handing in my macroeconomics final to our beloved professor. That historic moment will mark the end of my first semester in graduate school and the completion of one-fourth of my MBA degree .

In the meantime, I have tomorrow’s marketing final to worry about. The final will be on marketing the Xbox 360. Yesterday, our professors (I use the plural because this is the only class at Kenan-Flagler that is using the team teaching concept where two professors rotate to teach the class) handed out a 49 page packet of press releases, news articles, and pretty much everything you need to know about the Xbox 360. Tomorrow we will apply the concepts and tools we learned this quarter on the product.

Our professors showed us the following Xbox 360 television ad in class yesterday to get us hyped for the final.

Down the final stretch

I fired off the first batch of cover letters this morning. Wednesday is the last day of classes, I have an in-class final for marketing on Wednesday. My first “real” final is finance on Friday, followed by operations on Saturday, strategery a week from today, and macroeconomics a week from Tuesday. This year’s last exam is pretty late because they gave us an entire week off (plus two days) for fall break. I believe next year’s final exam schedule will be a bit earlier because we won’t have as much time off in October.

 

While we are on the topic of the next school year, congratulations to the Kenan-Flagler Class of 2008 early action applicants who received their acceptances today. For those of you that did not receive the news you were hoping for, don’t be discouraged. I recommend following up with the Admissions Committee by continuing to express your interest in the school. One way you can do this is by sending a letter along the lines of this sample form letter.

Sex in the Forbidden City

The December 12 issue of Time Magazine had an article about the changing sexual attitudes in China. The headline is so hilarious I cut it out and clipped it to my fridge.

"Sex, Please--We're Young and Chinese

A generation after Mao suits, China is coping with an epidemic of free love

Li Li has lost exact count of how many men she has bedded, but she knows the number is far above 100. "I don't keep statistics," says the former journalist, 27. But she isn't averse to kissing and telling. For the past couple of years, Li has kept a blog--written under the pen name Muzi Mei--that has chronicled everything from her penchant for orgies and Internet dating to her skepticism toward marriage when it means staying faithful to one man. This fall the Beijing resident posted a recording of her own lovemaking sounds that would make Paris Hilton blush. More than 50,000 people simultaneously tried to download the 25-minute podcast, crashing the host server. Despite government attempts to censor it, the sex diary is so popular that Li's pen name is intermittently the most searched keyword on China's top search engine. "I express my freedom through sex," says Li, unapologetically. "It's my life, and I can do what I want."

Trader at major Japanese bank mistakenly costs firm $224 million

How do you say "D'oh!" in Japanese?

"The trader at Mizuho Securities, who has not been named, fell foul of what is known in financial circles as “fat finger syndrome” where a dealer types incorrect details into his computer. He wanted to sell one share in a new telecoms company called J Com, for 600,000 yen (about £3,000).

Unfortunately, the order went through as a sale of 600,000 shares at 1 yen each."

There's more ...

"The slip caused immediate shockwaves in the Tokyo market as traders tried to guess which firm had made the mistake. Fearing the impact, traders sold shares in all Japanese broking houses and the sell-off led to the value of the Nikkei 225 falling 2 per cent. It was only later that Mizuho admitted that one of its traders had made the error."

But it doesn't end there ....

"If Mizuho has to accept the loss, it may have to sell many of its stockholdings to raise the money, creating further pressure on Japanese stocks."

And to add insult to injury ...

"As if the hapless trader was not unpopular enough, the firm also cancelled its end-of-year party, scheduled for last night."

The entire article is here. Enjoy.

In search of summer internship

One of the things I find overwhelming about business school is walking around with the knowledge that the decisions that I make over the next 17 months will affect a good portion of the next ten years of my life. I was feeling that anxiety last night as I looked at the Office of Career Services’ listing of companies that will be interviewing on campus starting in January. I have between now and next week to map out which companies I want to intern with and submit my resume and an individually tailored cover letter. The companies will then receive all the resumes and cover letters from Kenan-Flagler, make a decision as to which students they wish to grant an interview to, place those names onto their “closed lists,” and resubmit the information back to OCS. Students on the “closed list” then sign up for a time slot and any time slot that has not been spoken for by the pre-announced deadline are allocated to other students via a bidding system.

                                                

The last time I looked for a job was more than four years ago. I am once again feeling the type of anxiety and inadequacy that (I hope) is normal for all job applicants. You know you are about to enter a situation where you will be judged and you will find out just how strong your cover letter, resume, previous work experience, understanding of business concepts, and salesmanship skills are.

How universities manage their investments

I enjoy reading about the strategies taken by universities in managing their billion dollar endowments. There was an article in yesterday’s Daily Tar Heels about recent moves by UNC Management Company, the company in charge of managing the $1.4 billion UNC Chapel Hill Foundation Investment Fund. According to president Jon King, their strategy is to “find asset classes that are not the hot assets today — ones that may be a little bit out of favor — but still significant aspects of the economy.”  They did just that five years ago by investing in the energy and natural resources sector, which at that time was considered unattractive. Their investment paid off and returned a 45.7 percent gain in the 2004-2005 fiscal year.

 

The article also talked about investment strategies taken by neighboring schools. Some schools own positions in forests, which make money by periodically cutting down subsections and selling the timber. I know that Harvard University, which has the largest academic endowment, owns forest in New Zealand. The article mentions that it, along with Wake Forest University, own forest in the Pacific Northwest.

 

And in case anyone is keeping track, Yale has the second largest academic endowment with $13 billion, the University of Chicago has $3.6 billion, the University of Virginia has $2 billion, and Wake Forest at $1.1 billion.

 

7:40pm update: I found this article bookmarked on my computer about Yale's endowment's stellar return in the most recent fiscal year.

 

"Yale University's David Swensen, who oversees the school's $15.2 billion endowment, produced the highest returns among managers at the richest U.S. universities, beating his competitors at Stanford and Harvard with investments in hedge funds, real estate and private equities."

“Freedom is on the march”

"Tens of thousands of people marched through Hong Kong on Sunday to protest the slow pace of democratic reform in this former British colony, but the territory's Beijing-backed leader again rejected demands to set a timetable for achieving universal suffrage." - Washington Post article

I had mixed reactions to yesterday’s pro-democracy protest in Hong Kong. On the one hand, I was delighted to read about people around the world continuing to clamor for something as fundamental to the average American as universal suffrage. But at the same time, it angers me when I compare what's happening in places like Iraq, Afghanistan, and now Hong Kong, to what goes on in our own country where less than half of all registered voters bother to vote in most elections.

"Yours is a very bad hotel"

I had my first all nigher last night, stayed up most of the night working on the case competition, I slept for about two hours. Surprsingly, after my group's presentation this morning, instead of going home to sleep like I had planned, I ended up staying at McColl and going to class.

My marketing professor showed us a PowerPoint presentation that's been floating around the Internets titled "Yours is a very bad hotel."  It was an attempt by an irate customer to illustrate her frustration with the poor services she received at the DoubleTree Club Hotel in Houston, TX. It goes to illustrate something I thought about earlier today after my group had presented. I went onto the school's shared drives and looked at the PowerPoint presentations from last year's case competition participants. I was really impressed with their ability to make their point across using PowerPoint. I think PowerPoint is an incredibly important skill that I need to master in the upcoming seventeen months.