Dear Diary,
Scotland voted to stay part of Britain…
Even so, we’re considering a campaign to free Maryland (about which, more anon).
We are in Uruguay giving a speech to a group of Argentine investors.
What can we tell them that they don’t already know? They’ve seen it all.
Yesterday’s edition of El Clarín newspaper reported that the Argentine peso had dropped past the 15-to-the-dollar level for the first time. When we first came to Argentina – it must have been in about 2005 – we recall getting only 5 pesos per dollar.
“No one knows what the annual rate of inflation is,” says a friend. “Most think it is about 40%.”
Based on that alone, it should be obvious why the peso is dropping – to everyone but Argentina’s 42-year-old minister of the economy, Axel Kicillof, that is.
In loose translation from El Clarín:
Kicillof accused the US of having pushed the peso down. “Oddly, [US ambassador] Sullivan used the word ‘default’ [to describe Argentina’s failure to make the required payment on its foreign debt] when everyone knows it was selective… and then the dollar goes up and gives the impression of a general panic.
“Contrary to the opinion of the market,” Kicillof continued, “there is no economic or financial reason for the peso to trade at 15 to the dollar.”
Well, that pretty much settles it for us!
Fixing Prices
Meanwhile, over on page 10, the Argentine legislature is giving the US Congress a run for its money as the dopiest group of elected officials in the world.
They just voted in favor of a law that will give the government the power to control the economy more closely. (It’s done such a swell job so far!) Yes, among other things, the law gives the government authority to use “whatever method necessary” to set “maximum and minimum prices.”
Hey, you’re probably thinking, what a novel and clever way to stop prices from rising: simply set prices yourself. Why didn’t anyone think of that before?
Of course, they did. Many times. And every time, it was a disaster.
Set prices too low and you soon get shortages. Set them too high and your shelves groan with unsold merchandise. It should be obvious to everyone by now that only Mr. Market knows the proper market-clearing price.
Argentina is an adventure. Even for the Argentines.
We greatly admire their willingness to experiment with policies others have already proved don’t work. Argentines are always willing to have another go; maybe they’re just back-testing.
On the pampas, inflation, taxes and regulations seem as though they were designed intentionally to hinder economic growth. Anyone who is running a business has to find ways to cope.
Recently, we couldn’t get parts for our tractors… and couldn’t get new tires… because of restrictions on imports. We tried to send them from the US, but they got hung up in customs.
And trying to keep track of income and expenses is a nightmare…
Shining a Light on the Black Economy
Recently, we spent some time with an accountant, trying to make sense of it. He explained that the typical businessman has four sets of books.
“One is for what really happens… with some transactions in ‘white’ (I mean, at official rates) and some transactions in ‘black,’ which we don’t report. It also includes our exchanges of dollars to pesos – some officially, at the bank, and others let’s say, unofficially, on the street.
“Another one shows the commercial transactions in black and white, but all of the exchanges from dollars to pesos are at the official rate.
“And then, you usually want to keep track of only the commercial transactions in white… we don’t show the money we made in black… or the payments we made in black. But you can see the currency exchanges, from dollars to pesos, in black and white, as we did them.
“And of course, we have the accounts we report to the government – only the transactions in ‘white’ with our dollar-peso conversions at the official rate. This one is pure fantasy, of course.”
Our head was swimming. “You don’t declare any of the transactions that were in cash?” we asked.
“No… we have no paperwork to back them up.”
“Why not just issue purchase orders and receipts?”
“Oh, the counterparty wouldn’t accept them… he’d have to explain where he got the money.”
“Well… where did he get the money?”
“It’s black money. He probably sold something to someone else… who didn’t want a receipt either.”
“Well, then, what do you do with this black money?”
“We use it to pay our workers. Or buy things. Anything. But we also have to use white money.”
“Why? It looks like the whole economy operates on black money.”
“No, no… you need white money too. The white money is how Kicillof thinks the economy operates. We need to show him enough activity in white so he won’t come looking for the black.”
(Again, our admiration for the Argentine businessman who is able to deal with all these complications is boundless.)
Later, we were sitting at the dinner table with our capataz [ranch foreman]. “It doesn’t matter who wins the election,” he said. “Because Argentina’s problems are so profound… no one will be able to solve them.”
“No, no…” we told him. “I could solve all the problems in a couple of weeks. I would just eliminate all the laws and regulations that keep people from being able to work. Get rid of all trade and financial restrictions. Abolish all forms of government assistance and subsidies. And back the peso with gold.”
Our capataz doesn’t know much about economics. But he knows a dreamer when he sees one. “Easier said than done,” was his final comment.
On Monday: an homage to poverty.
Regards, 
Bill
Proof Value Investing Works
Yesterday, we talked about how – even when they’re calculated based on the past 12 months of per-share earnings – stocks’ price-to-earnings ratios really reflect investors’ earnings growth expectations.
And I hinted that this spells opportunity for vigilant investors…
First, let’s look at the historic data…
When you measure the returns of US stocks going back to 1926 (the year one of the most extensive publicly available data sources starts), the 30% of stocks with the lowest P/Es has delivered 18.6% annualized returns. The 30% of stocks with the highest P/Es has delivered 10.9% annualized returns.
So, there is clearly an advantage to buying stocks trading on low P/Es and holding them over the long term…
It’s counterintuitive for a lot of folks, but companies with fast-growing earnings (and therefore high P/Es) make lousy stocks. And those with less impressive earnings growth (and therefore low P/Es) make great stocks.
Why?
Because everyone knows companies with fast-growing earnings are great companies… and in their excitement, investors tend to overpay for those earnings.
As P/Es rise, investors can buy fewer dollars of earnings for each dollar they invest. This means that, for growth stocks to yield the same dollar amount of earnings as the market average, their earnings have to keep outpacing the market average.
Value stocks, on the other hand, have a head start. Because of their low P/Es, investors in these woebegone companies can buy more dollars of earnings for each dollar they invest.
And because earnings don’t move in straight lines but instead revert to the mean, the above-average earnings of growth stocks fall back toward the market average… and below-average earnings rise back toward the average.
Even worse, because there is so much optimism already factored into prices, when growth stocks beat earnings expectations their stock prices tend to rise only slightly. But when earnings disappoint, prices tend to fall dramatically.
The opposite is true of value stocks. Because expectations are so low for these down-and-outs, further earnings disappointment tends to lead to only slight drops in prices. But when earnings exceed expectations, their prices rise dramatically.
In other words, investors irrationally overvalue growth stocks (because they’re exciting) and irrationally undervalue value stocks (because they’re boring).
Clearly, the superior investment strategy is to buy value stocks selling at cheap prices… and avoid growth stocks selling at expensive prices.
The same goes for country stock markets. To make excess returns over the long run, you’ll want to avoid overpriced markets where investors are irrationally optimistic… and favor underpriced markets where investors are irrationally pessimistic.
More on where these opportunities lie on Monday…