First Do No Harm

By Rob McCreary

Freakonomics has really interesting podcasts, and the last one of a three part series on August 20, entitled “Bad Medicine” did not disappoint.   The long standing view of the big three causes of death was Heart, Cancer and Respiratory.  According to The Center For Disease Control, here is the list for 2014 sorted by the number of deaths:

  • Heart disease: 633,842
  • Cancer: 595,930
  • Chronic lower respiratory diseases: 155,041
  • Accidents (unintentional injuries): 146,571
  • Stroke (cerebrovascular diseases): 140,323
  • Alzheimer’s disease: 110,561
  • Diabetes: 79,535
  • Influenza and pneumonia: 57,062
  • Nephritis, nephrotic syndrome, and nephrosis: 49,959
  • Intentional self-harm (suicide): 44,193

This was before researchers at Johns Hopkins actually began to question the data. It turns out that the third leading cause of death in the US is not respiratory related at all, but rather medical error. Think of the millions of decisions including NIH funding, charitable giving, medical school curriculum, hospital protocols, career choices, doctor reputation and malpractice insurance premiums that were all predicated on faulty data.

Medical Error Was Not A Choice

This occurred because the death certificate process has an international code that does not include medical error as a cause of death and the medical profession, medical examiners, and funeral directors often controlled the answer. For decades the medical person filling out the death certificate usually listed the problem you were being treated for rather than the proximate cause of death. So if you were being treated for a heart problem, but the surgeon nicked an artery during a heart valve repair and you died on the table, the cause of death was heart disease.

Medical error includes a spectrum of mistakes both passive and active, ranging from misdiagnosis to acts of negligence like a surgical mistake, or injecting the wrong dosage of insulin. Johns Hopkins research also showed that the more experienced the doctors were, the more likely to cause your death than the least experienced. As the number of procedures increase so does the possibility of medical error.

Business World Has No Equivalents

The analogy to the business world would be faulty reporting on 10Ks and 10Qs because management selected the accounting treatment they were using, without disclosing how it impacted the result and without oversight from auditors or SEC. I am sure there are thousands of CEOs who would have supported a reporting category called gross revenue that was selected by the sales team! In that case an investor, lacking the true information might lose money on his investment, but at least he would not have lost his life.

The greater issue raised by this massive misclassification is why did it take so long for someone to figure it out? I wonder how many times a week some medical person was aware that the Center For Disease Control classification codes did not allow truth to be told? I am also shocked that the tort industry did not figure this out but it is probably because the misclassification helped their chances at trial. If a medical expert had a choice of medical error and did not mark it, that evidence from an expert would be hard to rebut. The trial lawyers were actually benefitted by the conspiracy of silence.

Unfortunately, the Freakonomics podcast missed an opportunity to explode the myth of expertise. There is too much fake news, bad science and intentional deception based on shaky experts who want to promote a social or political point of view whose opinion also serves a financial interest. We should all bring a healthy dose of skepticism to any point of view that cannot be tested, debated or validated, and an even a more suspicious eye when a lot of money is involved.

Experience Trumps Credentials In My World

For me, an expert must pass the Lisa Vito test. Lisa is Vinny’s fiancee in “My Cousin Vinny” and introduced by Vinny as an expert witness on general automotive matters. Given she is a woman in a southern courtroom and she speaks with a New Jersey accent, the prosecutor, Jim Trotter, objects to her expertise. Evidently working in her father’s garage was not enough. Prosecutor Trotter thinks he can disqualify her by asking a tricky question on ignition timing:

Jim Trotter: Now, uh, Ms. Vito, being an expert on general automotive knowledge, can you tell me… what would the correct ignition timing be on a 1955 Bel Air Chevrolet, with a 327 cubic-inch engine and a four-barrel carburetor?

Mona Lisa(scoffing) That’s a bullshit question.

Jim Trotter: Does that mean that you can’t answer it?

Mona Lisa: It’s a bullshit question, it’s impossible to answer.

Jim Trotter: Impossible because you don’t know the answer!

Mona Lisa: Nobody could answer that question!

Jim Trotter: Your Honor, I move to disqualify Ms. Vito as a “expert witness”!

Judge Haller: Can you answer the question?

Mona Lisa: No, it is a trick question!

Judge Haller: Why is it a trick question?

Vinny(to Bill) Watch this.

Mona Lisa: ‘Cause Chevy didn’t make a 327 in ’55, the 327 didn’t come out till ’62. And it wasn’t offered in the Bel Air with a four-barrel carb till ’64. However, in 1964, the correct ignition timing would be four degrees before top-dead-center.

Jim Trotter: Well… um… she’s acceptable, Your Honor.


Rob McCrearyFirst Do No Harm

Disrupting Trust and Validation Business

By Rob McCreary

When Luca Pacioli introduced double entry bookkeeping in the 15th Century that single idea spawned acceptance of the modern corporation as a vehicle for collaborative business because it created an auditable trail of financial entries. The third party trust and validation business was soon to follow and has blossomed and grown ever since.

Until I read the July 15 issue of The Economist I had never thought about what a big part of the world’s economy is devoted to proving ownership, validating compliance, keeping a perpetual record and managing lists.  “The Long Arm of the List” by the editorial board of The Economist points out that blockchain technology may disrupt a huge part of world GDP.

Validation Is A Huge Business

Now you find validation business everywhere; real estate title agencies, accounting firms, vehicle license bureaus, corporate trust companies, forensic auditors, notary publics, depositary trust corporation (“DTC”), Federal, state and local permits, product warranty registrations, Visa, Amex and MasterCard, art auction houses, central banks, commercial banks, international passport control, chip readers, password protectors and birth certificate . These businesses thrive by managing the complexity of validating credit, ownership, title or identity. They are the foundation of an integrated world of commerce and they are indispensable for now. They are also massively expensive, but worth the cost.

The Cost Of Friction Is High

Imagine a world where you only paid pennies for a real estate title search (now $80 per transaction), or a real estate title policy (now $300 per house transfer). Think about a ledger keeping community for the entire stock market and bond market that is paid in ETF units to validate every single change in ownership and is not owned by Wall Street. Think about an independent registry for collectibles and precious gems that is 100% accurate in proving a real Monet and the identity of the Hope Diamond. Think about not having to rely on bureaucrats for licenses and permits. What if you did not need Visa, MasterCard or American Express to vouch for your credit? According to The Economist, and many other futurists, the blockchain technology that underpins bitcoin may threaten to disrupt all these expensive third parties.

Computing Power and The Distributed Ledger

To understand the blockchain technology I use the analogy of real estate titles. It is possible to search the ownership of some pieces of property in England as far back as 1066. So if you are a Australian retiree who wants to buy a country farm in Essex, you can hire a title examiner to look at the ownership ledger for that specific legal description going back to the first owner. For a fee the title examiner validates the seller’s chain of ownership and ability to convey clear title to the Aussie retiree.

The blockchain technology does the same thing for every bitcoin transaction by researching its title back to the original issuance. According to people who really understand the underlying technology and business model, it can be adapted to validate anything with a unique signature. That could be a fingerprint, gem coloring, an artist’s signature, a CUSIP number, an iris, a bank account or a digital currency. The business model or rules for the community that is utilizing the blockchain technology can be customized to the particular industry.

For example, bitcoin only has two signatures. It has a receiving account number that is used to receive and hold bitcoin. It also has a super secret sending number that allows any party who has the sending number to transfer bitcoin from the holding account. Successful hackers must have both numbers to steal your bitcoin. It is almost like a bearer bond that is ripped in half and must be reunited to trade. Crooks can’t bribe someone to validate a theft because the ledger for every bitcoin transaction is distributed among thousands of independent “miners” whose computers compete to validate every single transaction. If one miner is ready to approve a heist but there is no match of sending and receiving numbers, 40 other computers will not validate and the transaction will not be approved. The miners are also paid in bitcoin so they have no incentive to undermine their own currency.

Will New Business Models Emerge

The same concept may work for gems, stock and bond ownership, bank and trust accounts, licenses, permits and even databases. What if database giants like Facebook, Amazon and Google did not have a complete record of your friends, what you buy and what you are searching on the web? It certainly would be a lot more private. Blockchain technology also has the potential to disrupt powerful incumbents like governments. The editorial board of The Economist questions whether politics will stop the distributed ledger:

“Each time we use a distributed ledger we participate in a shift of power from central authorities to non-hierarchical and peer-to-peer structures.”

While for profit incumbents will keep trying to discredit this new technology and politicians will find ways to legislate against it by predicting massive job losses and disruption of the current order, technologies like blockchain that can cut costs and simplify and protect consumers always get adopted in the long run.

Rob McCrearyDisrupting Trust and Validation Business

Invest Like Pooh and Eeyore

By Rob McCreary

Extended time with the grandchildren always leads to the irresistible logic of A.A. Milne and his principal spokesperson, Winnie the Pooh. One of Winnie’s most insightful observations is about doing, or in his case, doing nothing:

“People say doing nothing is impossible, but I do nothing every day.”

The investment world has apparently not heard of the House of Pooh preferring the more action oriented House of Morgan or The Rothschild Bank. In fact, if Winnie the Pooh visited any investment web site or read any financial publication he would find the incessant bias for action a long way from “doing nothing” at Pooh Corner.

Eeyore Investment Philosophy

His gloomy friend Eeyore reminds me of the host of value investors who are predicting the end of days or, at least, the end of the stock market going up. But Pooh’s advice to Eeyore is the same advice that Grantham, Mayo’s James Montier, a big fan of Winnie the Pooh, gave Barron’s in a recent interview by Leslie Norton:

“You can’t stay in your corner of the forest waiting for others to come see you. You have to go to them sometimes.”

So GMO, a value oriented investment firm, actually suggests how you act if you are an Eeyore and want to stay in your corner:

  1. Build a robust portfolio where you can survive many different outcomes
  2. Concentrate your investments in one thing that will generate returns
  3. Look at alternative assets that are not correlated to the stock market
  4. Consider the option value of having cash when dislocations occur

For James Montier this means emerging markets, merger arbitrage, TIPS, and short duration bonds. He suggests taking your equity risk where you are getting paid the most for it. Use leverage but not to the point where it forces you to sell a perfectly good investment at the wrong time. James Montier sees a stock market reversion in a short period of time (over 7 years), but Jeremy Grantham, his partner and the eponymous founder of GMO, does believe it is different this time and we will see a slow, 20 year reversion to the mean in the stock market.

Private Equity Can Learn From Pooh

In the private equity world we have remained disciplined around Winnie the Pooh advice as well. We try to understand the intrinsic value of industrial and service businesses in the lower middle market. We look for strong and predictable cash flows. We stress test optimistic growth assumptions; if you are surprised on the upside it will take care of itself. We use leverage, but rationally. We return capital to investors when leverage falls below the chicken index-1.5-2x EBITDA. We own 6-10 companies in a diversified portfolio. We are actively bidding in a sellers’ market and succeeding by patiently waiting for reversion through “busted deals” or a seller’s preference for co-investing with us.

We have our own recipe for successful investing that both Pooh and Eeyore could endorse:

  1. Buy at a reasonable valuation
  2. Have a margin of safety
  3. Align your rewards with investors
  4. Be transparent
  5. Partner with management teams
  6. Engage knowledgeable limited partners
  7. Do hard things early
  8. Sometimes do nothing
  9. Don’t be afraid to change your mind
  10. Challenge convention

These principles are not flashy but they are the foundation for our own House at Pooh corner.



Rob McCrearyInvest Like Pooh and Eeyore

Better Than Ohio Sweet Corn

By Rob McCreary

Writing a weekly blog is a privilege and I usually have more ideas than I can handle, but this week all the news was old news and all the problems were old problems. There wasn’t anything new and exciting until I saw this morning’s edition of The Wall Street Journal, “ObamaCare For Congress” by the Editorial Board of The WSJ. This opinion piece has restored my enthusiasm for politics and my hope for fairness:

Over the weekend Mr. Trump tweeted that “If a new HealthCare Bill is not approved quickly, BAILOUTS for Insurance Companies and BAILOUTS for Members of Congress will end very soon!” He later added: “If ObamaCare is hurting people, & it is, why shouldn’t it hurt the insurance companies & why should Congress not be paying what public pays?”

The WSJ” actually is giving Trump the game plan. It points out that many aspects of the ACA were legislated by executive order. That includes a provision that treats Congress as a small business allowing its employees to buy on exchanges meant for poverty level people:

The law did not specify what would happen to the employer contributions, though Democrats claim this was merely a copy-editing mistake. A meltdown ensued as Members feared that staffers would be exposed to thousands of dollars more in annual health-care costs, replete with predictions that junior aides would clean out their desks en masse. 

Mr. Obama intervened in 2013 and the Office of Personnel Management issued a rule that would allow employer contributions to exchange plans, not that OPM had such legal authority. One hilarious detail is that OPM certified the House and Senate as “small businesses” with fewer than 50 full-time employees, and no doubt the world would be better if that were true. This invention allowed Members to purchase plans on the District of Columbia exchange for small businesses, where employers can make contributions to premiums. This is a farce and maybe a fraud.”

Hope For Equal Treatment

I am completely overwhelmed by the hope that Nancy Pelosi’s staffers will have to pay the same premiums and penalties, and suffer the same frustrations, as the rest of us. This is the alpha and omega of populism. Congress is universally viewed as a smarmy group of elitists who often dine on K street sushi while the rest of us go to Taco Bell for chalupas.

Privileges Are Not Popular

We pay their minimum wage ($174,000). We pay their generous retirement ($139,000 per year for 32 years of service). Their eponymous boss allowed them to circumvent ObamaCare (buy on exchange intended for people under poverty level). They are exempt from traffic laws while traveling to and from Congress (think DUIs). They are not subject to the same insider trading rules that put Martha Stewart behind bars. They have a franking privilege which means they can send you endless solicitations for money without paying postage (why fix the post office). They get free airport parking at Regan National. According to the Motley Fool they can get up to 239 days off each year but the consensus is they get 110 “recess days” where they are allowed to work from home.  If they die in office they get $74,000 more than a Navy Seal.  They get a nice budget to form their staff ($1.2 mil for Congress and $3.3 mil for Senate).  I am not sure they have accountability to a boss other than lobbyists who get them elected (why reform campaign finance).  They don’t pay change fees on airlines. They don’t live where they work, and we usually pay their commuting expenses.

No wonder their approval rating is 20%.

Even Trump Can Execute This Plan

Trump has little media or bi-partisan support so far.  When the only guy you can recruit for replacement Press Secretary is nicknamed “Mooch” you know things are not going to change. But The WSJ is throwing Trump a bone by serving up an Executive Order game plan for reforming health care by making staffers eat the same drek they are serving us. Who is going to support Congress? They are more hated than Trump (39% approval rating). While this would mean Trump taking on venerable institutions that form the bedrock of our governance system I think a Trump Executive Order would force bi-partisan health care reform because ACA premiums are predicted to rise 30% next year. Self-interest will prevail.

Even if there is no reform, the consolation prize would be wholesale resignations by the army of junior staffers who have no real world experience but are doing all the big thinking for their rock star bosses. For me that would be better than Ohio sweet corn in August.


Rob McCrearyBetter Than Ohio Sweet Corn

Active/Passive Debate Misses The Pony In The Pile

By Rob McCreary

“Next the psychiatrist treated the optimist. Trying to dampen his out look, the psychiatrist took him to a room piled to the ceiling with horse manure. But instead of wrinkling his nose in disgust, the optimist emitted just the yelp of delight the psychiatrist had been hoping to hear from his brother, the pessimist. Then he clambered to the top of the pile, dropped to his knees, and began gleefully digging out scoop after scoop with his bare hands. ‘What do you think you’re doing?’ the psychiatrist asked, just as baffled by the optimist as he had been by the pessimist. ‘With all this manure,’ the little boy replied, beaming, ‘there must be a pony in here somewhere!’”    

–  excerpted from How Ronald Reagan Changed My Life, by Peter Robinson


Jason Zweig is a well-known finance columnist for The Wall Street Journal and also the editor of the revised edition of Benjamin Graham’s The Intelligent Investor (HarperCollins, 2003), the classic text that Warren Buffett has described as “by far the best book about investing ever written”.

Mr. Zweig recently published an article in The Wall Street Journal that captures one important aspect of the active versus passive debate. As the number of publicly traded companies shrinks through consolidation, acquisitions and mergers, there are fewer undiscovered gems, especially for value investors like Mr. Zweig:

In less than two decades, more than half of all publicly traded companies have disappeared. There were 7,355 U.S. stocks in November 1997, according to the Center for Research in Security Prices at the University of Chicago’s Booth School of Business. Nowadays, there are fewer than 3,600.A close look at the data helps explain why stock pickers have been underperforming. And the shrinking number of companies should make all investors more skeptical about the market-beating claims of recently trendy strategies.

Diminishing Opportunities

In 1999 we started CapitalWorks with an investment fund targeting unloved and misunderstood microcap public companies. Not only were many of these old economy companies out of favor due to the dot-com boom, but they were also extremely hard to research. The consolidation of regional securities firms into much larger broker dealers with sophisticated research departments left many perfectly great industrial and service businesses without any trading sponsorship or investment research simply because they were too small. Geography also was important because many of these microcap orphans were headquartered in the fly over zone. As a consequence there were hundreds of hidden gems waiting to be discovered with hard work of fundamental research and management meetings.

That opportunity space disappeared with the dot-com bust and the subsequent consolidation of survivors. On top of that trend, going public became a rare event as liquidity in the private markets became possible for the first time. Now there is so much less red tape and so much more liquidity that exciting new companies are finding private market ways to support growth and still monetize their investment:

“Back in November 1997, there were more than 2,500 small stocks and nearly 4,000 “microcap” stocks, according to the Center for Research in Security Prices. At the end of 2016, fewer than 1,200 small and just under 1,900 microcap stocks were left.

Most of those companies melted away between 2000 and 2012, but the numbers show no signs of recovering.

Several factors explain the shrinking number of stocks, analysts say, including the regulatory red tape that discourages smaller companies from going and staying public; the flood of venture-capital funding that enables young companies to stay private longer; and the rise of private-equity funds, whose buyouts take shares off the public market.”

Rise Of Private Equity

It is not surprising that the rise of the private equity asset class corresponds almost perfectly with the decline of the micro cap public asset class. The private equity model allowed many management teams to monetize their private investment and still have control of the company they founded. Many management teams also have serial reinvestment and exit cycles side by side with equity sponsors for whom they are owner-managers- two or three bites of the apple. The private equity model became  a better petri dish for growth companies than public markets over-regulated by Sarbanes Oxley and Dodd Frank.

Stress Testing Index Funds

It is interesting that the debate today is centered on whether active managers can outperform passive products like ETFs. Everyone is looking at the costs of active management rather than asking about the risks inherent in a collective product like an ETF. We simply don’t know how a product which trades directly but depends on unaffiliated third parties to stabilize its portfolio price will perform in a market meltdown. In a recent interview of retired value investor Bob Rodriguez by Robert Huebscher writing for Advisors Perspectives on June 27, 2017; I was shocked to learn how concentrated the passive products really are, and, in the opinion of a really smart retired guy, may be much riskier than they seem:

Thus, since 2007, indexing or passive activities have risen from approximately 7% to 9% of total managed assets to almost 40%. As you shift assets from active managers to passive managers, they buy an index. The index is capital weighed, which means more and more money is going into fewer and fewer stocks. When the markets finally do break, as they always have historically, ETFs and index funds will be destabilizing influences, because fear will enter the marketplace. A higher percentage of assets will be in indexed funds and ETFs. Investors will hit the “sell” button. All you have to ask is two words, “To whom?” To whom do I sell? Index funds and ETFs don’t carry any cash reserves. The active managers have been diminished in size, and most of them aren’t carrying high levels of liquidity for fear of business risk.

While I have written about ETFs and how Dodd Frank circuit breakers unintentionally caused many ETFs to hemorrhage in July, 2010, I have not found anything written about stress testing the ETF model. I know one thing for sure. The owner or decision maker on ETF products is probably the weakest hand at the table and the one most likely to fold at exactly the wrong time. This gives credence to Bob Rodriguez question about who is going to buy when the weak hands are all folding at the same moment on their ETF investments. The institutional arbitrage feature of an ETF is meant to follow, not lead, valuation anomalies so it is hard to predict what help, if any, will come from the arbs if ETF trading prices plummet due to a disorderly market. One might speculate that the arbs will short the market basket of securities if they think the weak hand capitulation will influence the whole market.


Rob McCrearyActive/Passive Debate Misses The Pony In The Pile

A Silver Mine For The Taking

By Rob McCreary


The Economist” understands something about retiring baby boomers that has eluded the money machine of American business. In a July 8th special report, the editors described the motherlode opportunity:

“With longer lives, more free time and a lot of cash, older people clearly present a “silver dollar” opportunity. In America the over-50s will shortly account for 70% of disposable income, according to a forecast by Nielsen, a market-research organization.   Global spending by households headed by over-60s could amount to $15tn by 2020, twice as much as in 2010, predicts Euromonitor, another market-research outfit. Much of this will go on leisure”.

The only organization that gets it is AARP which has a slick marketing appeal that confuses retirees into thinking they are buying the Platinum Card for retirement lifestyle. In fact, AARP is a sophisticated money maker with a political viewpoint I do not endorse.

With people over 50 controlling 70% of disposable income you would think someone would invent “Abergrammy and B Rich” as a specialty retailer providing trendy leisure wear for Old People (“OP”).  In my early legal career I actually did work for an entrepreneur who wanted to start a specialty retail chain called “Cane and Able”. I loved the business model of a one stop shop for all OP products and I also loved the name because of its biblical antecedents, but I was never sure that fratricide would sell in Brooklyn.

Mastering Subway Surfer

One of my grandkids could be the next Zuckerberg if he or she could invent a paid service that helps seniors master the intricacies of the internet of things and the devices that navigate its networks. All grandparents would certainly pay something for help on how to get under the first hurdle in Subway Surfer and learn to jump for gold coins. You can’t put a price on gaining some credibility with the under 6 years old crowd.

Mother of all APPS

I know we would all pay a small monthly fee to have a seamless and completely dependable password recall service. When they stopped accepting “Hello” I began to struggle. I am sure Amazon has Alexa working on a solution and will offer it for free so they can control access to every one of their competitors. This is the Mother of All Apps.

When someone demystifies the cloud and actually educates OP about it being safer than storing sensitive information on their computer and also closer to heaven so wifi will work in the afterlife, a new business channel will emerge. Someone other than AARP is going to create a data trove on $15 Trillion of spending power.

Fitness and The Zapper

Fitness can flourish if it allows a small group of well toned seniors to join (prepay annually) the 40 year old yoga classes. The only downside is turnover as many seniors will get stuck in the Pidgeon Pose and will require immediate emergency hip surgery. My brother-in-law has been going to Yoga classes for 5 years now and he has never moved past the Child’s Pose. For him it is touch your toes and never close your eyes.

Implants- not the body parts type- are a growth industry as well. You need a zapper mechanism that discourages excessive libation, reminds you to take your statins, gooses you off the couch, encourages you take the first 50 steps in the morning and interprets the importance of all spousal communication. In our house the most important communication always starts when we are 3 rooms apart. The staccato exchanges of “what”, “what”, “what”, “WHAT” “WHAT” ending with a crescendo “I CAN’T HEAR YOU” is the love language of the geriatric set.

Travel As A Substitute

Finally, there is travel. I think retirees are actually more interested in filling the time between meals than they are travelling. I really don’t agree with The Economist about leisure. Leisure time is really a curse and when someone figures out how to package “PURPOSE” for seniors, you will have the true motherlode. For now the “Love Boat” is a poor substitute for a generation with energy, money, intellectual curiosity and experience. If this group ever gets organized politically, it may become yesterday’s America. In any event, if I were a 30 year old with Fifteen Trillion Dollars up for grabs, I would be spending more time with the OP and their friends. The Mother of All Apps will reveal itself if you can become an early riser and a volunteer in a retirement community.


Rob McCrearyA Silver Mine For The Taking


By Rob McCreary

Everyone is talking about Bitcoin. Many investors, even those who never bought any, are now claiming to be early adopters. The world loves a winner and Bitcoin has outperformed just about every other asset class on the planet. If you bought $1,000 of Bitcoin in July 2010 at the opening price of 6 cents ($0.06) and held your 16,667 bitcoin until July 3, 2017 when it traded at $2,605.17 you would have $44.0 million of value. The same people who now are claiming Bitcoin victory probably also bought Amazon, Google, Apple and Netfix at the initial offering.

Actually, if you own 16,667 Bitcoin you know not to talk about it because that makes you and your family prime kidnap targets. Those people who boast about early investment aren’t real Bitcoin investors. The real investors are the ones with the Cheshire cat smile and a fuzzy recollection of its antecedents: “ I’m not crazy, my reality is just different than yours.”

The real Bitcoin investors have withstood a roller coaster ride and the chart below does not really demonstrate the 18% two day decline in June:



Source: Coindesk price of Bitcoin from inception


Bitcoin Has Survived Big Challenges

The biggest exchange and a trusted custodian of a large percentage of the early Bitcoin in circulation, Mt. Gox in Japan, was hacked in 2014 and $350-$400 million Bitcoin was stolen. The digital currency rebounded. New York State decided to regulate Bitcoin dealers who did business in the State of New York by creating a licensing process for companies like Coinbase. The guy who led the charge for New York, Benjamin Lawsky, got the legislation he wanted which put Bitcoin squarely within the regulatory purview of the New York Department of Financial Services. Like any good capitalist, Mr. Lawsky then resigned and went into the business of consulting with Bitcoin dealers who had to interpret and comply with the regulations he had just written. The currency rebounded again.


Bitcoin entered adulthood in 2015 and 2016 when it effectively provided wealthy Chinese with an escape route out of the currency restrictions imposed by the Chinese government to halt the flight of capital out of China. Given the easy conversion of Bitcoin to US Dollars and the more stable trading market, the only risk was getting caught trying to convert Chinese assets into Bitcoin.

A Schism Among The Users And Developers

Now that everyone wants Bitcoin I am wondering whether the business model is showing strains. First the price that a Bitcoin miner charges to validate a single transfer has increased from several cents to as much as six dollars. Bitcoin was supposed to lower the cost of friction but the computing power needed to validate the block chain ledger has exploded as the digital currency gains acceptance.

You also need patience to transact in Bitcoin. The average transaction now takes significantly more time than the early days(as long as 20 minutes) to be verified and confirmed.

Finally, the user group that interprets the rules for the Bitcoin business model has many fundamental disagreements principal of which is whether Bitcoin should have a fixed supply of 21 million Bitcoin or an expanded supply and trading characteristics like foreign currencies. The purists want a store of value, like gold, and an anonymous way to subvert fiat currencies. The expansionists are bothered by speed and transaction costs and often comprise larger groups proposing changes to shift the economic model in their favor.

On top of that Ethereum has emerged as a viable competitor to Bitcoin. Its chart looks like Corbett’s Couloir in Jackson Hole:

Source: World Coin Index Price Of Ethereum

As “The Wall Street Journal” points out in its July 3, 2017 edition, Bitcoin can no longer be used to buy a cup of coffee because the transaction price is $6x the cost. This is bad news for holders of Bitcoin because it relegates the digital currency to a doomsday asset class like gold. Given the state of the world, doomsday asset classes will remain popular with people who want some insurance against the manipulation of mainstream currencies by politicians. Whether it is Brexit, the US border tax, the Chinese currency restrictions or Argentina’s once-a-decade devaluation of its currency, Bitcoin will have a place but, for now, maybe not the one Satoshi Nakamoto, its anonymous founder, envisioned. But would you buy Ethereum?






Whimpy Economy At Its Zenith

By Rob McCreary

I’d Gladly Pay You Tuesday For A Hamburger Today

Bill Gross wants to sell you a bond. For that matter he wants to sell you trillions of dollars of bonds and, preferably, in one of his Janus products. He did catch my attention, however, with an interesting article in Wednesday June 14th’s edition of The Wall Street Journal where he predicts reversal of fortunes for investors who are confidently surfing an equity wave without understanding the jagged coral beneath them:

“Money will currently be made, or at least conservatively preserved, by acknowledging the exhaustion of “making money with money”. Strategies involving risk reduction should ultimately outperform “faux” surefire winners generated by central bank printing of money. It’s the real economy that counts and global real economic growth is and should continue to be below par.”

Mr. Gross is right about several things. The Fed’s “QE forever” campaign has created a financial Disneyland where returns on capital are available in only a few asset classes. Those asset classes, however, are squarely reliant on real economic forces that Mr. Gross fears will end the prosperity trade. Among them he especially fears demographics and productivity. Investments in productivity enhancements have diminished and the aging baby boomers just are not spending. There are a number of industries with a “Whimpy- Gladly Pay You Tuesday for a Hamburger Today” business model. Fixed future promises like life insurance, bank deposits, defined benefit pensions (private and public), Medicare, social security, annuities, interest rate swaps and long-term care insurance in exchange for a deposit or a premium dollar today are at risk:

“But asset prices and their growth rates are ultimately dependent on the real economy and, the real economy’s growth rate is stunted by secular forces which monetary and even future fiscal policies seem unable to reverse… Investors have discovered that making money with money is a profitable enterprise and have exchanged the support of central banks for the old-time religion of productivity growth as a driver of their strategy. The real economy has been usurped by the financial economy.”

In the private equity world we have confirmation of Mr. Gross’ real economy observations. Unit growth is hard to find in many of the industrial companies we see. Earnings and cash flow are often enhanced through a plow horse playbook of cost reductions, selective price increases, synergistic tuck-in acquisitions and working capital management. Larger companies increasingly manufacture their earnings by acquiring smaller competitors and, unlike other investment periods, are not penalized by the capital markets for lack of organic growth. Investments in productivity usually mean labor displacement first and innovation second. When once determined rivals like Dow and DuPont merge acknowledging they cannot grow the Whimpy economy is at its zenith and, like a financial “Ground Hogs Day”, rightly predicts a succession of unfulfilled Tuesday promises.




Rob McCrearyWhimpy Economy At Its Zenith

What If Facebook Were At Woodstock

By Rob McCreary

Harvard is among the most selective universities in the world. Gaining admittance is a passport to prosperity and elite networks. The waiting list must be as long as the line at the Apple Store at 9:59am on Saturday morning.  How, then, can ten of the most brilliant and well qualified young people in the world squander a place in the class of 2021 because of highly offensive public opinions?

No Public Record of Stupidity
In 1969 when I was admitted to college there were only a few ways you could reverse the good fortune of your anticipated matriculation. You could fail to graduate from your high school. You could commit a crime.  You could get lost at Yazgur’s farm never to be seen again.  Even if you were expelled from high school you often could still get your final transcript and the colleges were no wiser.  Everyone expected your opinions to be stupid, uninformed and controversial.  Just ask your parents.  But no one had a public record of those opinions.  Mark Zuckerberg changed that with Facebook which started innocently and has morphed into a powerful tool for marketers and an even more powerful enforcer of conformity.  Young people everywhere are trusting the public forum of social media to interpret their changeling character in the best possible light.  This naiveté is startling to me.  In all forms of social media many colleges and universities find a willing enforcer of group thought and political correctness. The Facebook effect is responsible for major changes in how colleges run from the building names on campus to the mascots and even the relationships between men and women.  Social media powers a god squad of self-appointed student judges who wield the power of inclusion to ostracize and create pariahs.  Young people crave inclusion and acceptance; so once you are out, there is little chance to get back in.  Social life is often altered for the outliers.

Dumbest Smart Guys
In 2017 the power of social media is demonstrated by the Harvard admission denials.  The original user group for Harvard incoming freshman was pretty much what Mark Zuckerberg had envisioned with more than 100 incoming freshman exchanging ideas and observations in a social media attempt at getting to know each other.  The 10 offenders must be the dumbest smart people on the planet because they obviously thought their incendiary freedom of expression was protected in the second chatroom where they posted  on horrible topics.  They revealed themselves to the world as bigots, racists, sexists and they paid the price as they should.

Why Go Public
I have avoided Facebook, Instagram, Twitter and most forms of social media because I see it as an intrusion on my privacy.  Why would I voluntarily publish information about me, my family, my friends, my movements, my grandchildren, my religion, my politics and my vacations?  Off the grid is actually far preferable in a world of cyber-crime, social media punishment and banishment, kidnapping and ransom, identity theft, sexual predation, and hacking and phishing.  This is common sense.  When is going public in a cyber world ever better than remaining private?

If Facebook or You Tube had existed in 1969,  the freshman classes of every college on the east coast would have been lighter by at least 10 men and women. Thank goodness for a chance to grow up.

I came upon a child of God
He was walking along the road
And I asked him where are you going
And this he told me
I’m going on down to Yasgur’s farm
I’m going to join in a rock ‘n’ roll band
I’m going to camp out on the land
I’m going to try an’ get my soul free


Rob McCrearyWhat If Facebook Were At Woodstock

Truth On A Slow News Day

By Rob McCreary


It is always interesting to read The Wall Street Journal (“WSJ”) on days when the NYSE is closed and mainstream business is snoozing.  Memorial Day 2017’s edition contained opinions you never read when the markets are open. While the mainstream bias of WSJ is still squarely in favor of groups who pay them, it was nice to see the other side of the story on a day when few advertisers would be reading.

Illinois Privilege Tax on PE Firms

Illinois is insolvent. It hasn’t passed a budget in two years. It needs revenue to pay for the mismanaged state pension plans and entitlement programs. As Kristina Rasmussen reported in a WSJ article on Memorial Day, May 29 the Illinois mess is as follows:

“Illinois hasn’t had a budget in two years, since the Democrats in Springfield continue to insist on more taxes. The state has $267 billion in unfunded retirement liabilities, a $14 billion backlog of unpaid bills, and a $7 billion projected deficit this fiscal year.”

To address this train wreck The Illinois Senate passed a 20% privilege tax on financial advisors that would apply to hedge fund and private equity managers. That legislation is now in the House of Representatives. If passed, the tax would certainly apply to portfolio company realizations. I am not sure whether it would also be a sur-tax on compensation and whether it would apply to stock brokers and investment managers as well?

Ms. Rasmussen suggests hunting productive people like PE firms will end poorly for Illinois. While it is a great political sport to impose a sur-tax on a small group of high earners, it is usually a fool’s errand. Ms. Rasmussen says PE managers can and will move to tax friendlier states and the multiplier effect will be greater than the legislature ever figured. There are many service jobs that support PE including law, accounting, due diligence, consulting, insurance, and recruiting.

Trump Will Prevail in Travel Ban

Until Memorial Day I had never read anywhere (including law school commentary) that President Trump will win if the US Supreme Court agrees to review the recent Fourth Circuit Court of Appeals legal decision declaring the President’s revised travel ban is illegal. According to the WSJ authors, David B. Rivkin, Jr. and Lee A. Casey a reversal is a sure thing:

“In ruling against the order last week, the Fourth U.S. Circuit Court of Appeals defied Supreme Court precedent and engaged the judicial branch in areas of policy that the Constitution plainly reserves to the president and Congress. The high court should reverse the decision.”

The story reviews legal precedent and concludes that the Circuit Court has clearly politicized its decision:

“It is therefore difficult to avoid the conclusion that the Fourth Circuit and the other courts that have stayed Mr. Trump’s executive orders on immigration are engaged in the judicial equivalent of the “resistance” to his presidency. Judges are, in effect, punishing the American electorate for having chosen the wrong president. That is not the judiciary’s role.”

Greedy CEO Stock Options

The Monday Memorial Day edition also slammed Patrick Drahi, CEO of Altice, for rearranging his compensation plan to provide more upside after his shareholders complained. You never read an article in the WSJ that slams executive compensation. In this case it was neither an American CEO nor an American company. The target was an Amsterdam based company’s leader about which the WSJ reported on the stock options as follows:

“Such a payout is a powerful incentive, but it is doubtful Mr. Drahi needs it. Never mind his outstanding stock options under separate agreements, which are collectively worth €55 million at the current share price; he already owns 59% of Altice—a stake worth about €19 billion today. If the share price triples, his stake is worth another €38 billion ($43 billion). This is surely incentive enough.”

The article incorrectly states that stock options are a way to give executives “skin in the game”.  As I have written before, stock options are a one way bet with the shareholders money and do nothing to align manager and owner. The article finally corrects itself and concludes that some managers like Mark Zuckerberg and John Malone do not need options because they are already aligned to shareholders through massive personal holdings.

In the PE world incentive options are typically granted only to managers who have already invested side by side and at the same price as the PE fund and share downside risk. The point about stock options is they have no downside. If you miss a plan, you don’t lose your own money.

Get Ready for the Next Holiday

Make Sure You Read the July 4th edition of The Wall Street Journal for all the news you can’t see on a real news day.




Rob McCrearyTruth On A Slow News Day