January 30, 2007 1:40

Remembering when Microsoft was scary

As Bill Gates makes the rounds promoting Microsoft's new operating system and everybody yawns, it's worth recalling just how scary and important his company seemed a decade ago.

Just to pluck a few examples from the 1990s pages of Fortune: Microsoft was going to extend its dominance from desktops to handhelds. It was going to take over the media, travel, and auto-retailing businesses. It was building a giant research operation to give it "a tighter grip over the future of computing." Its software dominance was a textbook case of increasing returns, where "the bigger your installed base, the better off you are," as economist Brian Arthur put it.

Microsoft's huge installed base has made it better off: Its earnings for the last four quarters totaled almost $12 billion, up from $3.5 billion in 1997. But the company hasn't taken over industry after industry, and in recent years it's been repeatedly upstaged by Google and longtime doormat Apple. Gates now makes it onto the cover of Time as a philanthropist, not as the "Master of the Universe." Microsoft is now a big, successful, well-managed company that still hasn't entirely figured out its second act.

There's a lesson in here for all you extrapolators out there (which is just about everybody; I certainly am one). Trends don't continue forever. Dominant businesses don't stay dominant forever (except maybe Exxon Mobil). The world is a charmingly (and sometimes not so charmingly) unpredictable place. Which means, of course, that Microsoft could become scary again any day now.

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January 29, 2007 8:09

Fundamentally okay index funds

I've always thought index funds were pretty cool. On average, stock mutual funds do worse than unmanaged indexes like the S&P 500 and Russell 1000. So if you buy a fund that only trails the index by a teeny bit, as most index funds are able to do because of their super-low fees, you're already doing better than most investors.

But when the stock market goes certifiably nuts, as this country's did in 1999 and early 2000, indexes weighted by market value (as most are) can take you to some weird places. In those years the S&P 500 became to a large extent a tech-stock index, just as tech stocks were reaching prices to which most wouldn't return for years. "It was certainly the opposite of buy low and sell high," is how Jason Hsu, director of research and investment management at Research Affiliates, puts it.

I had breakfast this morning with Hsu, who with his boss Rob Arnott came up with the concept of what they call "fundamental indexing"--picking the largest companies by cash flow or revenue or book value or dividends (or a mix of the four) and sticking them in a fund weighted by size. Wisdom Tree, run by Jonathan Steinberg (a.k.a. Mr. Maria Bartiromo) and backed by the likes of Jeremy Siegel and Michael Steinhardt, was first to market with a has gotten the most attention for its line of dividend-weighted exchange-traded funds. But Research Affiliates' FTSE RAFI indexes, weighted by a mix of fundamentals, are now available were first to market as ETFs through PowerShares and as mutual funds from Pimco.

Most new investment "products" are just new ways to charge investors fees for services of dubious value. But these fundamental index funds seem to offer something new and useful. Jack Bogle and Burton Malkiel, though, have been dumping on them, most notably in a Wall Street Journal op-ed last summer (available on Bogle's blog). Their argument is that, while fundamental indexing would have outperformed conventional indexing in recent decades, there's no guarantee that it will forever. Plus, the fundamental index funds have so far charged higher fees than cap-weighted index funds.

Fine, so we shouldn't be chucking out all existing index funds and replacing them with these newfangled ones. But I'm a little nonplussed as to why Bogle and Malkiel have made such a big deal out of this. "The gold standard is still holding the stock market and holding it forever," is how Bogle put it when I talked to him about it earlier today. I'm deeply hesitant to contradict the man. So how's this: Fundamental indexing looks like a pretty good idea, at the very least as a supplement to conventional index funds. But if you want to be absolutely sure, give it 100 years or so to prove itself.

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January 26, 2007 5:10

Charting Detroit's dependence on low gas prices

Every time bad news breaks for U.S. automakers, journalists and other observers offer one of two main explanations. One is that Detroit doesn't make very good cars, or at least doesn't make them efficiently enough. The other is that American automakers are so burdened by the retiree health care and pension commitments that they made when they were bigger, more prosperous companies that they barely have time to think about making good cars.

There's truth in both of those (personally, I lean slightly towards the latter explanation). But over the past 20 years the short-to-medium-term fortunes of the U.S. carmakers seem to be dependent mainly on one thing: The price of gasoline. The impressive return to profitability of Detroit's Big Three in the 1990s was in retrospect almost entirely attributable to the global oil glut that sent prices at the pump down and kept them there. Detroit makes its money on SUVs and pickup trucks, not on compact cars. Those don't sell well when gas costs a lot.

This is an obvious enough point, I guess, but I still thought it would be cool to plot GM's stock against the price of gas to see if the chart backed up the theory. It does. I used the average price at the pump for unleaded gas, as reported by the Energy Information Administration, and indexed both it and GM's stock price to equal 100 as of January 1995. (I thought about sending the chart to the time.com people and seeing if they could make it pretty, but decided that wouldn't be very bloggy of me.)

Gas prices have dropped in the past six months, and GM's stock price has risen. But a return to 1990s conditions really doesn't seem to be in the cards. Which is why I think we might keep reading scary headlines about the U.S. automakers for a while yet.

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January 25, 2007 6:28

How bobbleheads will save the American newspaper

My post the other day about the Webcomic Achewood (it was actually about newspaper economics, but since most of its traffic seems to have come from a link that Chris Onstad put up on his site, I guess that makes it about Achewood), has been generating a steady stream of mostly fascinating comments. Here are a couple about how media enterprises can make money in the age of the Internets that I think deserve their own post (I have abridged both, though). First, Kirk Alexander:

One salient point that I almost never see made when this sort of discussion comes up is that the profit margins that large corporate interests pursue still exist, but they are spread out over wider areas and require more consumerism. For example, the record industry might sell fewer cds now (for whatever reason) but there is more cross-branding and cross-marketing than ever before, between music placement in ads, between toys, posters, t-shirts, bobbleheads - the number of marketable products associated with a popstar has been steadily escalating in the last few decades to the point where certain name brand stars have billion dollar industries only tangentially supported by the product that they are famous for, ie, Snoop might make more off his Girls Gone Wild videos and his energy drink and his yadda yadda than he does off of music. ...

The same is potentially true for newspapers if they can find a way to be inventive. Achewood is a good example of this: the traditional cartoonist 15 years ago was paid by newspapers to license his cartoon, and that was the bulk of his salary. Achewood, however, is given away for free, but is subsidized by a large number of smaller industries underneath the achewood brand - t-shirts, cookbooks, shot glasses, etc. This is going to be harder for reporters, but I think good cartoonists will be able to survive just as much as they did before with some creative thinking and hard work.

My point is this: there are somethings that can be pirated and copied, and there are some that can't. Food, housewares and clothes have to be bought while media can be copied and re-transmitted for free. The media enterprises that are adapting well are more and more often lowering their profits or eliminating sales entirely, and then making up the profit on physical items that have to be bought - e.g., a band giving away mp3s for free but making more profit because they increased their fanbase and more fans bought t-shirts, achewood giving the comics away for free but selling signed prints, etc.

A reader named Amy had this response:

Kirk Alexander brings up an excellent point: Onstad and his wife appear to make their living off of Achewood, despite the fact that there is no charge to view any of the comics, including the whole archive. Onstad generates and provides the content direct, free of charge. He and his wife provide products related to the "brand" they have created and again are directly responsible for delivery to customers.

The middleman, which to keep with the syndicated comics example has historically been newspapers and periodicals, is cut out.

There are direct interactions between the artist and his fans, and the result is a personalization of the product on a level that isn't possible with something like Garfield.

There are non-comic equivalents, Craigslist, Amazon, and the like but the point remains:

Personalization is the future, and in the case of print-news, that's going to be a problem. Although, I think it will be more of a problem for national rags than for local (once they get with it).

Andrew said something similar above: Local periodicals have to personalize their content to local interests.

Google tries everyday to figure out what news I'd like to read and what ads I'd like to see, and bless its little heart, when it gets better at it, it's going to be amazing (at its worst, it's at least entertaining).

That said, I have to disagree with him on his last paragraph:

I don't think cutting-edge, centrist reporting is going to save newspapers. There tends to be this idea floating around that if given an informed choice, people would go for the balanced, rhetoric-free examinations of news, and I just don't think that's the case.

Look at the readership of the most blatantly biased political "news" blogs. What are the highest rated news radio shows? CNN/Fox News shows?

It's wall-to-wall pundits taking pejorative turns on the words "Democrat" and "Republican"...and actually not a whole lot else.

I don't know that I buy the argument that national media struggle more with personalization than local media do. I mean, Achewood is national. Global even. National magazines have long focused on niches that wouldn't be profitable on a local level. Beyond that, all I have to say is: Wanna buy a Time mug?

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January 25, 2007 9:25

Continuing to defend Larry Summers

As promised, I asked Larry Summers what he does for D.E. Shaw. Being the hedge fund guy that he is now, he wouldn't tell me anything on the record. But I can quote from the D.E. Shaw press release announcing his arrival:

Dr. Summers will be involved on a part-time basis in various strategic initiatives and high-level portfolio management activities and, along with the firm's other managing directors, in reviewing the overall operations of the D.E. Shaw group.

Also in the release (which I'd link to except it's a pdf; you can find it here), is this fawning praise from Julius Gaudio, a D.E. Shaw managing director:

Larry has both a world-class mind and a finely honed sense of what's feasible in practice. His involvement will meaningfully enhance our ability to identify and critically evaluate new investment opportunities throughout the world's capital markets.

Okay, so he's not in sales. And as the third-largest hedge fund company on the planet already, according to Alpha magazine, D.E. Shaw probably doesn't need to sign up any new clients. (Here's a great, if 11 year old, story on the firm, which is best known to people outside the hedge fund business as the place Jeff Bezos came from.)

Summers, by the way, did some important academic work in the 1980s and early 1990s showing how the prices of stocks and other securities can stray far enough from their correct values to allow smart speculators to make money. One of his partners in this research, Andrei Shleifer, co-founded what is now a giant money manager, LSV Asset Management. Another of them was blogger Brad DeLong, who will surely be announcing the launch of his hedge fund any day now.

To conclude: I still suspect that the hedge fund industry as a whole has jumped the shark. But Larry Summers is not Fonzie.

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January 24, 2007 10:39

Citi, Maria Bartiromo, and Roger Babson

There's a great story in today's Wall Street Journal (you have to pay to read it) about the brouhaha surrounding ousted Citi wealth-management boss Todd Thomson's expense accounts. He was taking Maria Bartiromo to dinner at Daniel (danger, cubicle-dwellers! site plays music!), flying her around Asia, and--most impressively, by my lights--getting a wood-burning fireplace installed in his 50th floor office (which became known as as the "Todd Mahal").

The justification for all of this was that Citi's wealth-management clients really liked schmoozing with Bartiromo and discussing their investments in front of a crackling fire. The cost of all this was coming straight out of their hides, of course, and it probably would have been much cheaper for them to take Bartiromo to dinner themselves and build their own danged fireplaces. But that's what the rich people wanted, Thomson told his bosses.

It all brought back to me something that investing legend Roger Babson wrote in his autobiography in 1935. (What!?! You haven't read it!?!?!) Decades before he became famous for his "Babsoncharts" and for predicting the 1929 crash, Babson was a kid just out of MIT working for a bond brokerage in Boston. He discovered before long that the bonds he was selling (to customers that included his family and friends back home in Gloucester) were marked up massively from the going price down in New York. He complained to his bosses, got fired, and set up his own discount bond-brokerage business. It was a flop. As he wrote 35 years later:

I did not realize that most investors had rather pay considerably more for the same bond if purchased from a fine office with expensive mahogany furniture, than to buy it from a little fellow like me who paid only fifteen dollars a month for desk room and slept in a hall bedroom. Such is the frailty of human nature! This, to a large extent, explains why investors have always got stuck and probably always will! Congressional legislation may provide investors with better information, but it will never provide them with self-control or eliminate their pride.

So true. Although that fireplace at Citi does sound really cool.

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January 24, 2007 9:50

Defending Larry Summers

A commenter to my post on hedge funds argues that since Larry Summers is an economist, he's not necessarily just hedge fund window dressing. Larry's not just an economist, he's one of the great economists of his generation. But I still don't believe David Shaw hired him for advice on arbitrage strategies. That said, I'll send Larry an e-mail and ask him what he actually does at D.E. Shaw. (Although that place is mysterious enough that if he tells me, he may have to kill me.)

John Snow also has a Ph.D. in economics, Richard Breeden has an awful lot of market experience (although he's never managed money before), and Madeleine Albright presumably knows a few things about risks and opportunities in emerging markets. I'm not saying these guys are nitwits. I just think the best money managers are hungry and stealthy and unconventional. Already successful, famous people don't really fit that bill.

That said, I fully agree with the commenter's final assessment that, "When Norm Mineta and Elizabeth Dole start hedge funds, panic."

Update: Here is my post on Larry's response.

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January 23, 2007 10:21

Remember Social Security?

So I didn't actually watch the State of the Union address, other than the Dikembe Mutombo moment. Veronica Mars had a monkey to find, Alabama was playing Auburn in basketball ... Plus, I got out of political reporting a long time ago in part because I really can't take speeches.

Still, I am capable of doing a text search, and so I did one on the speech a couple of minutes ago on the phrase "social security." Here's what I found:

Social Security and Medicare and Medicaid are commitments of conscience--and so it is our duty to keep them permanently sound. Yet we are failing in that duty--and this failure will one day leave our children with three bad options: huge tax increases, huge deficits, or huge and immediate cuts in benefits. Everyone in this Chamber knows this to be true--yet somehow we have not found it in ourselves to act. So let us work together and do it now. With enough good sense and good will, you and I can fix Medicare and Medicaid--and save Social Security.

Hard to disagree with any of that. But given how brief the passage was, I took it as a declaration of surrender. Yeah, there was that "let us work together and do it now" line. But he didn't really mean that, did he? This is going to be the next president's problem. (And the one after that, and the one after that ...)

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January 23, 2007 11:18

Another sign of the impending hedge fund apocalypse

Daniel Gross has a new piece up on Slate about all the former big-name government officials joining or starting hedge funds. He lists a few (Madeleine Albright! Larry Summers! John Snow! Former SEC chairman Richard Breeden!), then writes:

Let's set aside the question of whether the arrival of politicians is a neon sign to hedge-fund investors to Cash Out Now!

No. No! Nooooo! Let's not set that aside. That is the big question. Actually, it's more of an answer. It's sort of like the "skyscraper index" that my former Fortune colleague Devin Leonard wrote about a couple years ago: When a company erects a giant new skyscraper as its headquarters, sell the stock. New skyscrapers are expensive, they're extraneous, they're a sign that an organization has lost its way.

At hedge funds, the boldface names actually do serve a purpose: They help get the fund's salespeople meetings with pension fund managers and rich people. They're asset gatherers. But that's a bad sign, too. For decades, mutual funds gathered assets while the much-smaller hedge funds focused on beating the market. Not surprisingly, mutual fund returns tended to trail the overall market while hedge funds appeared to beat it (there's a lot of controversy about whether they actually did, but, uh, let's set that aside). Now the hedge fund industry has $1.43 trillion under management (according to the latest data from Hedge Fund Research). I'd say its market-beating days are behind it.

Update: I've responded to one of the comments (the one defending Larry Summers) here.

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January 23, 2007 9:07

How Achewood is killing the American newspaper

In his paean to Webcomic Achewood the other day, my fellow time.com blogger Lev Grossman mentioned in passing that "I always loved comic strips--that was the sole reason my family ever bought the Boston Globe growing up."

That got me thinking. There's been a ton written about how Craigslist is wiping out the newspaper classified advertising business. It's doing it with such ease in part because Craig Newmark isn't really a capitalist, and thus doesn't charge much for ads, but mainly because there's no particular connection between the classified ads in a newspaper and anything else in the paper. The newspaper is just a distribution channel for the ads, and now a far more efficient one has come along.

But it's not just the classifieds. Some newspaper buyers--like the Grossman family, apparently--have been getting it just for the comics. Others have been buying it for the supermarket sale ads, others for the stock market tables, others for those swell Cal Thomas columns on the op-ed page, others for the weather forecast, others for movie showtimes, others for sports scores, others for stories on national and world events, and yet others for the local news, sports, and lifestyle coverage. The size of that last group is anybody's guess, but it has to be significantly smaller than the total universe of newspaper buyers.

The local newspaper, in particular the big metropolitan daily, is a distribution channel--a series of tubes, if you will--for a whole bunch of stuff that its staff doesn't create, along with a little bit of stuff (articles) that they do. In most cities it was until recently a monopoly distribution channel, and therefore staggeringly profitable.

Now most of that stuff can be delivered significantly more efficiently online by people who have nothing to do with the local newspaper. The only possible exception is local news, sports, and lifestyle coverage. So newspaper owners and prospective newspaper buyers have been emphasizing that lately, and rightly so. But delivering local news to people who want it, either on paper or online, is never going to be anything close to the spectacular business that serving as a metropolitan area's chief distribution channel for information, advertising, and comics was.

Which leads me to a couple of thoughts:

1) You'll occasionally hear people attribute newspapers' struggles to the lameness of the articles they print. There are certainly lots of lame articles in newspapers. There were 10 years ago, too. Newspapers weren't struggling then. Some of that may have to do with the fact that the Internet makes it easier to find better articles elsewhere. But that has to be a pretty minor factor in comparison with the distribution-channel breakdown outlined above. (Although I do find this theory intriguing.)

2) All of the established media face new competition these days. But for most--national newspapers, small local papers, TV stations, magazines, movie production companies--it's a case of losing relative market share and/or figuring out how to deliver their product via the Internet. That will be tough. Some will go out of business. But I can't think of anybody else facing the same utter destruction of their business model that the metro daily newspapers are.

Update: Thanks for the comments (I found Cosmic Ray's to be especially heartening), and sorry for taking so long to get some of them posted. My headline, by the way, was meant ironically. (Movable Type doesn't appear to offer a special irony font.)

Update 2: I put up a post highlighting a couple of the comments here.

Update 3: Warren Buffett weighs in (on newspaper economics, not on Achewood) here.

Update 4: Yet another post on newspapers (this one outlining some reasons for their troubles beyond the loss of a distribution monopoly).

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January 22, 2007 11:33

The social responsibility of Milton Friedman

As of today, I write for Time, and the Curious Capitalist is back. I'm finding it a very strange experience to start work at an actual news organization after being immersed for weeks in the (re)writing of a book. I haven't been reading newspapers, I've barely touched the telephone, and the only places on the Web I've been going to regularly have been sports sites (there's nothing like being stuck in the middle of the fourth draft of Chapter 14 to make a man check the Liverpool-Chelsea score every three minutes). I'm completely out of it.

I do know a lot, though, about the history of the efficient market hypothesis and the path that it and some related ideas out of the University of Chicago took as they wended their way into the economic mainstream (because that's what my book is about). One of the landmarks of that history, in my telling, was a famous article that Chicago economist Milton Friedman wrote for the New York Times magazine in 1970. "The Social Responsibility of Business Is to Increase its Profits," was the headline. Argued Friedman:

In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has a direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.

As sifted through the ideas of Michael Jensen and William Meckling, who proposed that a company's stock price was a near-perfect measure of whether its executives were doing the work Friedman laid out for them, this became the doctrine of "shareholder value" that business executives across the land purported to embrace in the 1990s.

So far, so good. I'm a big Friedman fan, and I agree that corporations that put other goals above long-run profits are looking for trouble. But long-run profits are hard to pin down in the here and now, and while stock prices (because they reflect investors' estimates of future profits) are the best single gauge, they're beset by error and noise. In the last years of the 1990s boom, lots of corporate executives did enormously destructive things in pursuit of higher stock prices.

Which brings me back to Friedman, and his line about making "as much money as possible while conforming to the basic rules of the society." He treats those "basic rules" as exogenously determined. They're a given, and executives have to live with them.

But that's not the way it works at all. Corporations fund massive lobbying efforts in Washington. They hold great sway with the setters of accounting standards. They influence our very customs. And so relying on the relentless pursuit of profitability "within the rules of the game," as Friedman put it elsewhere, is not a reliable route to economic nirvana. The rules of the game have to be part of the discussion as well.

I know I'm not the first person to realize this. Come to think of it, Jack Bogle recently wrote an entire book more or less on the topic, The Battle for the Soul of Capitalism. Perhaps it's time for me to take it off the shelf and read more than just the one page where Bogle recalls being asked a question by a "young journalist" named Justin Fox. But first, I'm going to read a newspaper.

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January 3, 2007 9:12

The Curious Capitalist makes it into Keith Kelly

So there it is in Keith Kelly's column in today's New York Post, the news that this blog (which has probably had about 10 readers in the past month, since I 've had my head in a book and haven't been posting) is leaving Fortune.com (and CNNMoney.com) for Time.com. Kelly fails to mention that I'm also leaving Fortune magazine to write a weekly business and economics column (working title: "The Curious Capitalist") for Time. But hey, print's dead, right?

Actually, I sort of thought the latter news was more important, given that I've been writing this blog since September and I've been at Fortune for almost 11 years. Plus I'm told a few million people still read Time magazine. On paper!

Anyway, yes, this blog is moving to Time.com. (And I'm making the big, scary move today from the 15th floor of the Time & Life Building to the 24th.) The current plan is to maintain some ties with CNNMoney, but I'm not exactly sure how that's going to work or what my URL will be at Time.com. In any case, you can always find the blog at curiouscapitalist.com. Not that I'll be posting a lot before the week of Jan. 22. Still got that book to finish first.

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