The only thing necessary for the triumph of evil is that good men do nothing…

Do you want a clear conscience after Election Day 2020?  I do.  So I BOUGHT one by taking action now.  I just gave not-a-lot-of-money to six Democratic Senatorial campaigns.  You can buy that same peace in about 10 minutes – one entry of your credit card number is good for all the links below.  You’ll like the person in the mirror a little better for doing it.  I promise.

  1. Sarah Gideon in Maine (vs Susan Collins) –
  2. John Hickenlooper in Colorado (vs Cory Gardner) –
  3. Mark Kelly in Arizona (vs Martha McSally) –
  4. Cal Cunningham in North Carolina (vs Thom TIllis) –
  5. Amy McGrath in Kentucky (vs Mitch McConnell) –
  6. Theresa Greenfield (vs Joni Ernst) –

Why give to Senate campaigns? $10 each; or $50; or $250.  $60, $300, or $1,500 is a small price to pay to reserve the right to say “I did what I could.”  Everyone can find some money and ten minutes.

  • Your dollars go a lot further in a Senate race.
  • You don’t have to agonize over which Presidential candidate to support. These are clear front-runners who need your money NOW.  The Presidential campaigns will do just fine without you.
  • We already know what happens if a Democrat wins the White House, but Mitch McConnell still runs the senate.  Remember the stasis and frustration of Obama’s last 6 years in office.  Nothing got done after the Senate flipped.  Feeding the national frustration that brought us Trump.  McConnell laughing all the way to the bank.
  • If Trump wins and the Democrats win the Senate/House, the nation will be OK.  Trump will be reduced to railing from his twitter account.
  • If a Democrat wins the White House and McConnell stays in power, we’re guaranteed 4 years of conflict and partisanship.
  • If Trump wins and McConnell stays in power, you’ll at least avoid the shame of knowing you could have done more.
  • All the candidates above are viable incumbent-defeaters.  The longest shot is Amy McGrath in Kentucky.  But I believe no dollar spent on defeating McConnell is ever wasted.  Never forget McConnell flat out refused to let a Spring 2016 Supreme Court nomination go through.  That flagrant foul arguably put a deeper hole below the waterline of American Democracy than anything Trump has done (so far). 

Trump grabs the headlines, but the real evil lies in his enablers.  Craven, self-interested, sell-outs who’d rather rule a ruined hulk than give up power.  Mitch McConnell and the Lapdogs.  Yertle the Turtle on his throne of minions.

Humor aside, we are living through a moment of “The only thing necessary for the triumph of evil is that good men do nothing.” A lesson I’ve really taken to heart from recent reading.  I’m horrified about the direction this country is taking.  But I had an awkward moment a few months ago after reading “Defying Hitler:  A Memoir” – an excellent, gripping, highly readable book written in 1939 before WW2.

Was I doing any better than the upper-middle-class people who complained about this vulgarian racist and his craven followers, but did precisely nothing to stop them?

I was finally moved to act by a 2005 book I’m reading now – “The Anatomy of Fascism” by the (excellent) historian of inter-war Europe Robert Paxton.  More on that later.

Right now, click those links folks!  Buy yourself some peace.


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Pelosi’s Impeachment Delay. Stop Stirring and Wait for More Turds to Surface?

I think Nancy Pelosi is hoping and waiting for “the” under-the-waterline leak that torpedoes the Trump administration’s impeachment defense.  A smoking gun memo.  Or a White House official breaking ranks and testifying.

That isn’t a guarantee this will happen and she’s got plenty of other good reasons for a delay.  But this alone argued for a pause in stirring the pot.  Some particularly foul-smelling turds might just bob to the surface.

It is clear and obvious such turds are dammed up behind the White House’s stonewalling.  The Administrations general indiscipline also makes it likely someone will let one slip.  Either a self-serving jerk (“Hello Mr. Bolton, so happy you’ve decided to come clean.”) or maybe an honest patriot (another whistleblower?  The person who wrote “Anonymous?”)

We’ll just have to wait and see.  Maybe nothing comes out.  Maybe some New Year’s soul-searching or lawyer-client chats or self-serving calculation delivers a bombshell.

More broadly, I think delay is the right strategy.  Yes, delay means impeachment will fester and soak up airtime into 2020.  But that is a good thing in my view.

Trump-land thrives on keeping people off-balance with rapid-fire narrative progression.  Never let a story get stale.  Even a fresh outrage is preferable to letting any one negative story fester too long.  The audience gets buried, perplexed, and ultimately numbed to the dizzying. overwhelming shocks.  Sort’ve like the Group 3 dogs in the Learned Helplessness experiment below.

Letting impeachment fester threatens to slow the mad carousel of confusion that protects Trump.  If it slows it down enough, other turds will likely bob to the surface and stay in focus… And that is a self-reinforcing cycle that even Trump may fail to break.  Although he’ll probably start a war with North Korea if he really has to change the subject…

“Learned Helplessness”     

American psychologist Martin Seligman initiated research on learned helplessness in 1967 at the University of Pennsylvania as an extension of his interest in depression.[5][6] This research was later expanded through experiments by Seligman and others. One of the first was an experiment by Seligman & Maier: In Part 1 of this study, three groups of dogs were placed in harnesses. Group 1 dogs were simply put in a harnesses for a period of time and were later released. Groups 2 and 3 consisted of “yoked pairs”. Dogs in Group 2 were given electric shocks at random times, which the dog could end by pressing a lever. Each dog in Group 3 was paired with a Group 2 dog; whenever a Group 2 dog got a shock, its paired dog in Group 3 got a shock of the same intensity and duration, but its lever did not stop the shock. To a dog in Group 3, it seemed that the shock ended at random, because it was their paired dog in Group 2 that was causing it to stop. Thus, for Group 3 dogs, the shock was “inescapable”.

In Part 2 of the experiment the same three groups of dogs were tested in a shuttle-box apparatus (a chamber containing two rectangular compartments divided by a barrier a few inches high). All of the dogs could escape shocks on one side of the box by jumping over a low partition to the other side. The dogs in Groups 1 and 2 quickly learned this task and escaped the shock. Most of the Group 3 dogs – which had previously learned that nothing they did had any effect on shocks – simply lay down passively and whined when they were shocked.[5]

As you can see, I’m heading back into political commentary in 2020.  Figured its more salient than interest rates.  And more interesting now.

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Over-Paying for Under-Performance. Calix’s Board Has Lost Control and Authority.

I am publishing the attached letter here to ensure it is publicly available to those who might have an interest in Calix.  If it is of interest, keep on reading.  If not, I’ll be back with my usual programming probably sometime after the immanent birth of my 2nd child.

Link to a better formatted PDF is below.  Full text follows.

Letter Calix Board Have You Lost Control V2 10 Dec 2019

December 11, 2019

Calix’s Board of Directors Individually and Collectively.

c/o Corporate Secretary, Ms. Suzanne Tom, Calix

2777 Orchard Parkway,

San Jose, California 95134

Dear Mr. Christopher Bowick, Ms. Kathy Crusco, Mr. Kevin DeNuccio, Mr. Mike Everett, Mr. Don Listwin, Ms. Kira Makagon, Mr. Michael Matthews, Mr. Kevin Peters, Mr. J. Daniel Plants, and Mr. Carl Russo.

Dear Members of the Calix Board,

First let me offer my sympathies. You must be feeling at least a little embarrassed after being had so publicly and nakedly over a barrel.

Your CFO and EVP just forced you to cough up almost 3.5% of Calix‘s equity. Just to keep them showing up for work. Part of a team that has missed Board targets 3 years in a row.

It is obvious Mr. Sindelar and Mr. Weening’s had the whip hand in this negotiation.

It is equally obvious the Board, on the receiving end of that whip hand, has lost effective control and authority.

Mr. Weening and Mr. Sindelar took advantage of your weakness. Created, ironically, by their failure to execute. They dictated their terms. With a gratuitous relocation bonus as the cherry on top. I don’t blame them. They took what they could get. And they took a lot.

The Board was in no position to bargain.

We Just Got Held Up in Broad Daylight

The scale of that capitulation bears witness to the Board’s current impotence. It is clear who was dictating terms to whom.

Options for 1,910 shares over 4 years. Almost 3.5% of the company. $15 million at today’s stock price. Probably $25-$30 million if Calix ever achieves its potential (or a takeover premium). About 1/5 of current revenues. Almost equal to Calix’s total cash G&A spending.

Putting a bright line under the Board’s loss of authority, you couldn’t even hold Mr. Weening to a commitment made in writing in his 2016 employment agreement. Mr. Weening was supposed to initiate a move to San Jose in 2016. 3 years later, he’s holding us up for a gratuitous $225k to (finally) deliver on that contracted commitment. He clearly has the whip hand.

You agree that your relocation shall be initiated within the first twelve months of your [June 27, 2016] employment and completed within 24 months of your [June 27, 2016] employment.Per a (public, May 20, 2016) copy of Mr. Weening’s contract.

Over-Paying for Under-Performance. Evidence The Board Has Lost Control and Authority.

We just got rolled How else could one characterize handing over 3.5% of the company to an executive team that has consistently missed its targets?

Lacking bargaining power, you must have had no other choice.

How did Mr. Sindelar and Mr Weening back the Board into a corner like that? They leveraged their prior failures. The sum of those mistakes has left a precariously weak Calix unable to credibly threaten them with replacement. You were negotiating with no credible alternative option.

They knew (and you knew) they are currently irreplaceable.

  • After Mr. Billings quit in September, Calix couldn’t afford any more executive departures.

  • Its hard to hire competent executives into any company with a wafer thin cash cushion and a history of missing targets.

  • Hobby farms have particular trouble attracting talent. The problem of being run for one man’s pride vs. everyone else’s profit. Real professionals know that. They have their own pride. They want to be on a winning team.

  • It has always been hard to find people willing to work with Carl – as you hopefully know. It is only getting harder. Carl’s been plowing a wide furrow with a big personality in a small industry for a long time now. And his last real success was back in 2002.

The Compounding Costs of Continuing Incompetence

Why couldn’t the Board at least avoid this negotiation? Delay to some time you were less helpless?

Likely because Mr. Weening and Sindelar forced the issue – leveraging their busted 2019 bonuses after missing their own targets.

Lacking a credible threat to replace Mr. Weening and Mr. Sindelar, the Board had no choice but to capitulate. Handing over this new, egregious retention package…

  • because quitting was a credible threat for Mr. Weening and Mr. Sindelar. Mr. Billings had just quit. And they weren’t getting a bonus because they’d missed their target for the 3rd year in a row.

  • They missed targets because they didn’t adequately buffer the botched execution of the 1Q19 manufacturing shift out of China. They also failed to land any new marquee customers in 2019.

  • Partly because Calix was too strapped for cash to fund a more prudent manufacturing transition plan or inventory buffer; Or to fund adequate sales/marketing outreach (e.g. free demo systems).

  • Cash got so tight the Employee Stock Purchase Plan became a material source of funding. Notably not included as a risk factor in your most recent 10Q filing. A sort of stealth equity raise for (now probably) over $10m at $5.661 a share (~40% dilutive as of yesterday).

  • Cash was tight because Calix burned its cash reserves in the 2017 money bonfire of badly executed Services contracts (how really do you “achieve” a negative 30% Gross Margin?!?). With executive oversight so weak that it took months to understand how bad the damage was (much less avoid the botched execution in the first place)...

  • because, just before that 2017 debacle, management’s blithe over-confidence and detachment from the day-to-day had also led Calix to throw $40m of precious cash into a spectacularly ill-timed buyback.

What Harvest Will Your Executive Team Reap for These Seeds of Disaster They Themselves Sowed?

3.5% of the company…

If they’d screwed up more, would the Board have given them 5%?

The Fig Leaf of Carl’s Non-Participation Hides Nothing.

One might seek refuge in the argument that CEO Carl Russo isn’t taking part in this insider bonanza. This overlooks the obvious. In relative terms, it cost Carl nearly nothing to forgo those option grants.

Carl is not at Calix for the money. Calix is Carl’s hobby farm. He’s in it for the status.

Presumably – like many men of a certain age and wealth and in the twilight of their careershe is hanging on the reassurance of continued relevance. That is worth far more to Carl than a few million dollars.

By that same token, the Board’s has no financial leverage over Carl. You know that. Your leverage lies in threatening his sense of status.

Yet that leverage remains un-exercised. Leaving Carl (and Calix) effectively un-governed. Compromised governance is at the core of any hobby farm.

One Accommodation Leads to Another. A Slippery Slope.

Mr. Weening and Mr. Sindelar are in it for the money. And they have just taken advantage of Calix’s compromised governance with spectacular success. Extracting an egregious amount from us. Knowing we had no choice but to capitulate.

You must acknowledge that vulnerability stems directly from the Board’s prior accommodation of the executive team’s serially poor execution. If Calix was in less dire straits, you could and would have sent them packing.

Instead, you let yourself get backed into a corner. And they had you over a barrel.

What to Do? We Cant Let the Inmates Keep Running the Asylum.

Individual Board members should take action or exit. Don’t go along to get along. When this rock gets turned over, you will own whatever comes crawling out from under it.

  • Consider how the Board might re-assert its authority and take corrective action. Advocate to force that action.

  • If you realize the Board can’t (or won’t) take action, then resign. Do yourself a favor.

The Board as a body needs to address its evident loss of authority;

  • If the Board can see a path to effective action, then you must take it.

  • If you cannot (or will not) re-assert control. Invite someone else to take control and take action in your stead.

    • Calix has great fundamental potential if managed capably with sufficient capital.

    • It would be obvious negligence to leave that potential value un-realized.

    • If internal competence and capital aren’t up to the task, you must look for them externally. Someone with a deeper bench and more cash.

Potential Value is Worth Zero If Left to Rot.

Mr. Russo and potentially other Board Members will likely argue a change-of-control premium is worth less than Calix’s potential value as a stand-alone company.

I wholly agree. A well-managed Calix is worth more stand-alone.

But Calix is not well managed. Leaving the same team in place repeats the same experiment hoping for different results. Their track record doesn’t support that hope.

AXOS won’t be market leading forever. It value will fade.

A sale will realize more value than Calix flailing on as the poorly managed, weakly governed hobby farm the Board has let it become.

A change-of-control would actually be a re-establishment of control. A Board with proper control and authority does not over-pay for under-performance like this.

Sale or Flail. Any Other Ideas?

The only choices on offer to shareholders now appear to be;

  1. A sale to someone with more competence and capital.

  2. More of the same. Weak execution by the same team. Repeating the experiment hoping for different results.

If you see are other choices, we are all ears.

Drop some of us a call. It wouldn’t take much time. There are precious few left to pick up the phone. Most of your holders are index and quant funds (for a reason).

Nokomis finally threw in the towel last quarter. Maybe call them too? Ask why…

Don’t Be a Naked Emperors’ Nobleman…

I’ll leave you with the “The Emperor’s New Clothes.” Ask yourself; “Do I really want to keep playing the role of Carl’s Nobleman here?

The noblemen who were to carry his train stooped low and reached for the floor as if they were picking up his mantle. Then they pretended to lift and hold it high. They didn’t dare admit they had nothing to hold.

So off went the Emperor in procession under his splendid canopy. Everyone in the streets and the windows said, “Oh, how fine are the Emperor’s new clothes! Don’t they fit him to perfection? And see his long train!” Nobody would confess that he couldn’t see anything, for that would prove him either unfit for his position, or a fool. No costume the Emperor had worn before was ever such a complete success.

“But he hasn’t got anything on,” a little child said.

“Did you ever hear such innocent prattle?” said its father. And one person whispered to another what the child had said, “He hasn’t anything on. A child says he hasn’t anything on.”

“But he hasn’t got anything on!” the whole town cried out at last.

The Emperor shivered, for he suspected they were right. But he thought, “This procession has got to go on.” So he walked more proudly than ever, as his noblemen held high the train that wasn’t there at all.

You can try to shush the little boy. Mr. Listwin tried that. He initially chose to suppress my April 24th letter addressed to the full Board. Forcing my follow-up letter on April 28th that he could not suppress. That sequence of decisions is itself evidence of the compromised governance that Calix’s Board must address.

The obvious will, however, remain obvious. The next shareholder to call it out will likely be larger and even less pleasant to deal with. And they will see this letter.

Sincerely yours,

Steve Kamman



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The Fed Isn’t Manipulating Mr. Market. Mr. Market is Manipulating the Fed.

I remain amused worried by the persistence of the “Central Banks are manipulating rates!” myth.  Particularly among so many self-identified free market types.  It is a comforting myth.  And yes, the facts point in a deeply discomforting direction.  But FRED* doesn’t lie.  Conclusion first.  Facts follow.

  1. The market is driving rates.  The Fed is dancing to the market’s tune.  Its a Wizard of Oz act.
  2. The market has told us two things.
    1. Short-term rates above 2% are too high.
    2. Short term rates around 1.5% might be OK.
  3. Rough but accurate math:  Long-Term Rate = Economic Growth Rate + Inflation Rate.  Re-arrange that and you get Inflation = Long-Term Rate minus Economic Growth.
    1. The market gives us 30 year (2.23%) and ten year (1.76%) rates.
    2. The San Francisco Fed estimates long-term economic growth of 1.5%-1.75%, based on immutable (and low) population growth and a reasonable guess on productivity growth.
    3. That solves for inflation between zero and o.5% (1.76% – 1.75%  = 0.01%,  2.23% – 1.75%  = 0.48%)

Inflation between 0% and 0.5% is scary as hell.

If you don’t believe me, google “deflation” and its consequences (or wait for a future blog post).  No wonder so many people are sticking to the more comforting narrative that “the Fed is manipulating rates.”    Because deflation is super terrifying.  Even a permanent low rate scenario is pretty terrifying too.

A lot of people are ignoring the above,  But the facts are pretty clear.  The above seemed highly plausible a few months ago.  The recent upward turn in long-term rates makes it even more clear.  The market is marking up future prospects as the the Fed cuts short-term rates, the market started raising its long-term rates.

So we might be OK with short-term rates around 1.5%.  Which is a heck of a lot better than a macho Fed-caused recession from over-high rates.  But it leaves no room for inflation in that long-term growth + inflation equation.  And that is the ugly truth.   

The graph below shows

  1. The Fed’s short-term target interest rate (red line)
  2. The market’s 10 and 30 year bond interest rates starting Jan 1 2018.

[iframe src=”″ scrolling=”no” frameborder=”0″style=”overflow:hidden; width:670px; height:525px;” allowTransparency=”true”>

The Fed nearly doubled its target rate over 2018 – from 1.25% to 2.25%.  The (free) market played along until early  November.  Note that market rates started tanking before the Fed’s last rate increase around December 21.  The S&P500 was tanking too.

The Fed, chasing the market’s lead, started cutting its target rate down to 1.75 today.  Markets kept leading the Fed all the way.  Today, with the Fed’s rate at 1.75 and pretty clear signals of another cut to 1.5%, the market did something different.

Market rates have started going up.    The 10 year and the 30 year are ticking up.  The yield curve has un-inverted itself.

Yield Curve – 10 Year Treasury Minus the 2 Year Treasury

[iframe src=”″ scrolling=”no” frameborder=”0″style=”overflow:hidden; width:670px; height:525px;” allowTransparency=”true”>

* FRED is the St Louis Fed’s excellent and free data charting system.  “Download, graph, and track 590,000 US and international time series from 87 sources.”

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“Trump veered… like a squirrel caught in traffic”

So I’d decided to break my self-imposed politics ban about a week ago.  Election is coming up so politics are actionable and just too salient and…   Then I got a stomach bug.  Then the rest of the family got the stomach bug…  Some posts marinating but the piece below deserves wider distribution.

FYI the guy was General Mattis speechwriter.

“For the remainder of the meeting, Trump veered from topic to topic—Syria, Mexico, a recent Washington Post story he didn’t like—like a squirrel caught in traffic, dashing one way and then another. The issues were complicated, yet all of the president’s answers were simplistic and ad hoc. He was shooting from the hip on issues of global importance. With that, the meeting ended.  I learned an important lesson that would pay off when Trump returned for a briefing the following January: only use slides with pictures … no words.”

In crowd psychology terms, the Trump phenomena is reminding me more and more of a financial market bubble.  Note that in both cases, you are OK in steps 1 and 2.  We all do some of that just to stay sane and make decisions.  The agonizing losses start on the slippery slope into steps 3 and 4.

  1. Develop a thesis.
  2. Over-weight facts that support your thesis, underweight facts that don’t.
  3. As the un-supporting facts pile up, construct a narrative that depends less and less on facts and more and more on some unseen “its different this time” belief.
  4. Narrow your information flow to only confirmatory sources to keep the facts/belief dissonance within tolerable levels.  Choosing the model in your head over observed reality.

The “being wrong” part isn’t so damaging.  The danger lies in the very human instinct to double down on a false belief vs admitting you were wrong. We’ll gladly invent “facts” and twist our initial narrative rather than face up to that truth. Choosing the model in your head over observed reality.

When large groups do this, it can be incredibly powerful and long-lived. The dot-com bubble and the real estate bubble were exactly that phenomena.  All bubbles are.  People who stay home in the face of hurricanes (“I got through the last one“) or stay put in the face of immanent genocide (“they are our neighbors! They’d never do that!“) are also doubling down vs facing up to facts.  It is very human behavior.

A bunch of emotionally attached, “traditional Republicans” are sliding down that slippery slope right now.  Doubling down on a fantasy (“He’s fighting Deep State corruption!”) to avoid an uncomfortable truth.

The smarter ones are starting to peel away and acknowledge reality.  That is how bubbles eventually pop.  But the main body is still doubling down on the fantasy – hence Trump’s stable ~40% approval rating.

Meanwhile, the facts keep piling up.  Even the best deep state conspirator couldn’t make up the color and detail of that piece above.  The more reasonable and likely explanation is the simplest one.  He’s telling the truth.  Meaning we all should be much more afraid than we currently are.   

Of that 40% who still approve, I’d guess half are too dumb/ignorant to see it.  Half are “seeing” it, but choosing not to deal.  Hence the increasingly brittle, fantasy-driven narrative coming out of formerly serious people and institutions (e.g. the Wall Street Journal).  My guess is that the smarter half finally peels off.  The bubble collapses as they do.  My greatest fear is I’m over-weighting their intelligence…  🙂


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“Given Treasury Rates, Earnings and Cash Flows Today, Stock Prices Are Not Unduly High”

I don’t often re-post other content, but the piece (link in full below) is worth sharing.  It is a “where are the markets now?” piece that very tidily sums up the main (credible) arguments for over or under-valuation of financial markets.  It is readable, clear enough for a non-expert reader to follow the gist, and balanced.  In other words, something I wish I’d managed to write myself.

I agree with his conclusion with a similar dose of caution.  Equity markets simply aren’t looking all that overvalued although we could collectively frighten ourselves into a sell-off regardless.

A few points that really stood out for me.

  • Interest rates are low, but central bankers have had only a secondary role.Conspiracy theories are always difficult to confront, but at the heart of this one is the belief that central banks set interest rates, not just influence them at the margin. But is that true? To answer that question, I will fall back on a simple measure of what I call an intrinsic risk free rate, constructed by adding the inflation rate to the real growth rate, drawing on the belief that interest rates should reflect expected inflation (rising with inflation) and real interest rates (related directly to real growth).  Looking back over the last decade, it is low inflation and anemic economic growth that have been driving interest rates lower, not a central banking cabal. It is true that at the start of October 2019, the gap between the ten-year treasury bond rate and the intrinsic risk free rate is higher than it has been in a long time, suggesting that either Jerome Powell is a more powerful central banker than his predecessors or, more likely, that the bond market is building in expectations of lower inflation and growth.
  • Stocks are richly priced, relative to history, but not relative to alternative investments today
    If you are convinced by one of the arguments above that stocks are over priced and choose to sell, you face a question of where to invest that cash. After all, within the financial market, if you don’t own stocks, you have to own bonds, and this is where the ground has shifted the most against those using the mean reversion argument with PE ratios. Specifically, if you consider bonds to be your alternative to stocks, the drop in treasury rates over the last decade has made the bond alternative less attractive. In the graph below, I compare earnings yields on US stocks to T.Bond rates, and include dividend and cash yields in my comparison:

    In short, if your complaint is that earnings yields are low, relative to their historic norms, you are right, but they are high relative to treasury rates today.

  • Though I have confessed to being a terrible market timer, the implied ERP [Equity Risk Premium] has become my divining rod for overall market pricing. An unduly low number, like the 2% that I computed at the end of 1999 for the S&P 500, would represent market over-pricing and a really high number, such as the 6.5% that you saw at the start of 2009, would be a sign of market under-pricing. At 5.55%, I am at the high end of the range, not the low end, and that backs up the case that given treasury rates, earnings and cash flows today, stock prices are not unduly high.

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A Global, 20-Year Garage Sale. Ugly for “Safe” Asset Values.

Today’s FT brings a tidy, cogent, Japan-based example of the risks of so-called low risk assets when demographics turn against you.

We Are All Japanese Regional Banks.  We Just Don’t Know it Yet.

The (paper) Financial Times has a great article on page 7 about a Shimane Bank – a regional bank in Japan.  If this were just a Japan problem, this would still be useful forewarning (Page 8’s main article is “US Banks to Warn Investors of Grim Outlook [Driven by Falling Interest Rates]“).  Anyone who’s driven through quaint, semi-abandoned towns in Italy, Spain, or Trump country in America is seeing the same dynamic.  Most of us just haven’t connected the dots.  I’m going to pull some selected quotes/facts to tell a broader story.

In order to return to profit, Shimane Bank plans to ramp up higher-margin lending to “medium risk” companies, which did not meet its financial standards in the past. But in a prefecture where the population is already 25 per cent below its peak, and projected to fall another 15 per cent by 2045, good credit risks are hard to come by

…the problem [may be] more severe than just a declining net interest margin in their home market. He believes past forbearance has left the regional banks stuck with many loans to small companies where the owner is about to retire or the collateral has dubious value.

A Conclusion As Clear As a 2% 30 Year Treasury Rate.

Returns on a lot of “low-risk” asset classes are going to suck.

  1. There are a whole lot of nominally populated spots on the map that are in terminal decline.
  2. There are a whole lot of still nominally worth-something assets in those areas.
    1. Most obviously the unwanted homes themselves (quaint in Italian/Spanish villages, less quaint in dying US farm towns).
    2. Less obviously the nominally operating businesses in those towns – the car dealer, the grocer, the gas station.
  3. All those assets are still carried at a positive dollar value on someones books.  It might be a bank that’s lent them money.  It might just be the informal books of Grandma and Grandpa.  That is just an accounting detail.  Collectively, we are still pretending these places are worth “something.”
  4. In fact, they are worth nothing or less-than-nothing.  If/when it comes time to sell those assets, you will get pennies on the dollar at best, more likely zero, and at times someone will have to pay to exit (e.g. all those underground gasoline storage tanks won’t un-dig themselves).

Ask Not For Whom the Bell Tolls, It Tolls For Thee.  Garage Sale.

Abandoned towns make dramatic examples, but the less dramatic are also obvious and MUCH larger in scale.  Consider the carrying value vs the real-world re-sale value of the toys and diversions of early retirement.  We are on the cusp of the largest. longest-running garage sale the world has ever seen.

  • Motorcycles (Harley Davidson sales have sucked for years as used bikes flood the market).
  • RV sales dropped 4% from 2018 vs 2017 in the middle of a strong economy.  That may just be a blip, but a lot of used ones will be coming back on the market soon.
  • Second homes.  The Grandkids are grown up and the Kids can’t afford the upkeep given their stagnant incomes.

We aren’t into the mega garage sales when primary homes and their contents start selling.  Downsizing is only starting up.

And it isn’t just toys.  Think of all those rotting strip and enclosed malls that can’t find tenants.   The bridges that need upkeep,  The 1960’s school buildings and town halls that need a re-build.  It isn’t just the boomer’s personal possessions.  It is the whole infrastructure built for the education, upkeep, and entertainment.  Most of it needs substantial renovation and some of it just isn’t needed at all as population shrinks.

As all those individual assets get sold, the mark-to-market reality of carrying cost vs actual “value” is going to be ugly.  Less obvious but more worrying, that “safe” bond debt pile the boomers are buying into (to fund their retirements) is at least partially supported by those same fantasy asset values.  The Japanese regional bank problem writ large.

The Increasingly Desperate Search For “Safe” Assets.  Individually Sensible.  Collectively Self-Destructive.

For this, I’ll go back to that FT article.  The Japanese Regional Bank dynamic in it is worryingly reminiscent of the US Savings and Loan debacle of the early 90’s.  Faced with dead-man-walking loan books, banks rational move it to make otherwise insane bets in the hopes for a one-in-a million reprieve from disaster.  Individually sensible, collectively disastrous.

…In provincial towns across the country, bankers are looking at relentless declines in their income, leaving dozens of teetering institutions with an incentive to gamble on risky property loans or exotic investments overseas.

“Japan has built up the world’s largest net foreign lending position. Japanese financial institutions pump this capital out to the rest of the world: they are the beating heart of international capital flows,” said Shannon McConaghy, an asset manager at Horseman Capital in London, who follows the regional banks.

“The reduction in their return, due to negative rates, has forced the heart to take on more and more risk to keep on beating. The problem arises when this risk stresses the heart so much that capital stops beating out.”

Holding more than $3tn in assets, Japan’s regional lenders are bigger than the Italian banking system, and their excess deposits make them a crucial buyer of everything from collateralised loan obligations in the US to covered mortgage bonds in Denmark.

If this were just a Japanese bank problem, it would be worrying enough.  The S&L crisis was ugly.  But the same zombie asset army is walking in Europe and creeping into the US.  Note the increasing gloom in European banking (Deutsche Bank goes splat) and now US banking (FT’s page 8 article).

What I’m wrestling with is the above doesn’t necessarily mean that so-called “risk” assets are doomed as well.  The trite example is that we are still in the middle of a massive Technology revolution.  There is real value creation there – often via creative destruction of the old.  I know and live that every day.  So how do we reconcile that obvious value accretion with the broader trend of asset value write-downs?  That awaits more thinking and another post.

Also a few caveats/clarifications.

  1. US boomers may be particularly navel-gazing, but they aren’t unique.  The post-war baby boom happened across the developed world.  Europe and Japan hold useful lessons and shouldn’t be ignored.
  2. I’m a cranky Generation X member myself, but the views expressed here are not part of some generational warfare agenda.  I’m just trying to make sense of a time that seems out of joint.
  3. The boomers like to personalize everything.  And yes, this is (still) all about them.  But only to the extent that boomers exist in large numbers, are pushing towards 70, and will collectively shuffle off this mortal coil over the next 20-odd years.  As they trod that path, their scope for collective or individual action becomes increasingly limited and/or irrelevant.
  4. Confronting that increasingly limited scope for personal action at the end of life is a hard thing for any one person to face.  That whole generation’s existential crisis will (negatively) color the cultural zeitgeist/tone of the next 20 years as much as the harder facts below.
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Analysis Paralysis. Baby Steps. What is the What?

I’ve been running myself in circles trying to figure out the whole negative rates/inflation/global outlook thing.  Usually writing it out helps, but not in this case.  But seeing if some baby steps might help break the writers (and thinker’s) block.

I have had one very calming analytical breakthrough in the last week or so.  I’d been burning a lot of cycles trying to figure out why rates are so low globally.  I’d got some ideas, but nothing definitive.  It finally occurred to me that the WHY doesn’t matter.  I can just take the WHAT for granted and move on from there.

What is the What?  Risk Free Returns Will Suck.

Returns on low-risk assets are going to suck for a long long time.

The current 30 year treasury yield as of September 04, 2019 is 1.97%.  Risk-free (and a lot of risky) bond rates across most of Europe are outright negative.  For all the loud protestations about Central Bank manipulation, those are largely market-driven rates.

A bond investor buying today will probably lose a little ground to inflation year after year.  Even outright deflation probably won’t save fixed income investors.  They might break even on their bond investments, but all their other assets (Real Estate) would lose value.

Bonfire of the (Boomers) Vanities.

Its worth remembering that Sherman McCoy, Bonfire of the Vanities 80’s Master of the Universe, would be a cranky 70-year old man today.  Looking for a safe return to fund his twilight years.

That incoherent howling heard from so many quarters is the Baby Boomers (or their financial advisors) trying to twist their way out of an inescapable, market driven, read-it-in-the-paper-every-day truth.   Because they are (or were) counting on those bond yields to finance their retirement.

If we shout loud enough, Daddy will give us back those 4%-6% treasury rates we see as our birthright.  We’re OK tanking the economy and impoverishing our grandkids to save our own skins.  After all, self-absorbed pursuit of our selfish best interests (conveniently re-narrated as the “common interest” because that was true for most of our lives) is just our nature…

I say incoherent because the boomers themselves are the authors of their own troubles.  The engine driving rates ever lower is their collective, global urge to move into lower-risk assets as end of life nears.  It is a self-destructive, self-reinforcing cycle.

Risky Asset Returns May Suck.

One way or another, you are going to have climb a long way out on the risk curve to make a decent return.

Pushing back on the other side of the economic equation are the non-Boomer, still-working-age generations.  That is one reason why the (relatively young) US has positive rates why (relatively old) Europe and Japan don’t.

Ummm, Grandpa?  I gotta buy a house and pay the mortgage and we haven’t seen decent wage gains in like forever so….

Yes there is a lot else going on (hopefully this post sparks further thinking).  But under it all its just demographics and an ugly tug of war between an aging generation and everyone else.  At least in the developed world.  Japan went into that demographic spiral first.  Europe is following.  The US is touch and go (higher birthrate and net immigration).

The question remains,.  What the heck to do about all of this?  Hoping this baseline gives me the mental closure to move forward.

Any and all feedback would be deeply appreciated.

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The 737 Max, DSL Networks, and the Creeping Rot in Our Current Model of Shareholder Capitalism

Our current economic model does a lot of things well, but it reliably fails with long-lived assets.  That sounds like a pretty bloodless comment, but the consequences are – literally – murderous in some cases.  

In telecom, we are watching the slow-motion equivalent of the Boeing 737 MAX debacle.  The cancer is incremental investment in an asset (the 737 airframe, copper-based networks) that have hit the end of its useful operating life.  When the truth becomes impossible to ignore and the bill comes due, all that incremental spend gets written off with the obsolete asset.  Leaving you strapped for funds and time to replace it.  The sunk cost fallacy leading on to its logical,  self-destructive end.

Its a bit depressing if you are trying to maintain faith in shareholder capitalism.  About 20 years of pretending a totally obvious problem and need wasn’t there.  Until the creeping crisis accelerates to ramming speed.  It makes me think of the Hemingway quote: “How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.”

I kept going back to accounting 101 for asset-heavy businesses.  Incremental capital investment doesn’t magically generate (or demand) incremental revenues.  The whole point of asset lives and depreciation expense is to estimate how long until you need to replace that asset. At the end of that life, you must re-invest to maintain the existing revenue stream.  There is ZERO incremental return on that investment.  Just the privilege of staying in business.

  • The 737 was past its sell-by-date. Boeing knew it. But they tried to get out one more turn of the crank by slapping on new engines and using software to cancel out the resulting balance problems. Hundreds of people have died from that greedy calculus.
  • The copper network has been past its sell by date for decades now. The Telcos invested in increasingly fancy and expensive DSL gear to get a few more turns of the crank out of it. 20-30 years that could have been spent rolling out fiber at equivalent or lower total cost. Now that bill is coming due. People haven’t necessarily dies as a result, but rural and less-affluent areas lacking decent broadband are struggling to keep or attract businesses and jobs. Helping to feed the anger that is tearing away at our national fabric.
  • How many public infrastructure assets – roads, bridges, airports, subways – are creaking under endless layers of fresh paint  instead of being replaced wholesale? 

The 737 and Telecom examples aren’t the only ones. This seems to be a recurring problem with our current economic model. Managers charged with stewarding an asset loot it instead.  Shareholders cheer them on. The logic is “we’ll get all the cash flows and the next guy will be left holding the bag.” The negative externalities of that under-investment – rural blight and hundreds of people killed – are never factored into that calculus.

What follows is a more telco-specific rant. It’s what inspired this post but its a bit inside baseball.

After reading the CenturyLink and other telco transcripts. A durable, 10-20 year trend is getting underway.

  1. CTL’s prepared comments started with fiber Fiber FIBER! everywhere.  You would’ve thought it was Zayo’s call.  OR a re-run from 2000.  Most shocking was the whole “we’re going after SMB out of region” comment made in the Q&A.  Wow.   I haven’t heard a telco talk that much about building out new fiber plant since, well, last week’s Verizon call.  And the Vodafone call.  And most other recent telco calls.  Except AT&T – which only confirms the trend as T is always the dumb money.  Seriously, the shift in tone and focus was remarkable.
  2. If VZ and AT&T’s wireline business held a stand-alone call, they would sound exactly like CTL.  The voice revenue gravy train is finally grinding to a halt.  Consumer yes, but more so SMB.  The stats on the CTL call were pretty horrifying.  It’s not the revenues they need to replace, it’s the 99% gross margin profits.  Being telcos, they are reacting to the obvious at least 5-10 years too late, but they are most definitely reacting.
  3. The only hope is high-speed data delivered over a fundamentally lower cost network.  Which is what Verizon is actually doing under the cover of this 5G build.  Building out fiber for 4G backhaul and to sell real high-speed data services to businesses all the way down to SMB.  Like CTL, Verizon can see the rot in its own business.  So it might as well exploit that take-away opportunity out of region while shoring up its own.
  4. It all sums up to a wave of local network investment we haven’t seen in decades.  If they don’t invest, we have the Frontier call to remind you where things are headed.  That is worth a look.  Cutting EBITDA guidance in half because revenues are falling faster than they can cut costs.  There is no bottom to that pain on their current course.  Their path out is replacing those voice revenues with broadband.  That needs 1 GB speeds to be viable long-term. And that capex spend can’t be covered by existing (falling) cash flows.  So they’ll go bankrupts, wipe out the debt, and spend frantically to make up for 10 years of lost time.  Expect the same from Windstream.
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Calix – If You Sh*t in Your Own Backyard Often Enough…

I figured I’d publish my post-quarter Calix update here.  As someone noted to me, I probably won’t be getting a Christmas card from them.  🙂  But if the emperor is prancing around in new clothes made of nothing more than delusion, I’m not obliged to play along with the charade.

See below for the post-call note I sent to Calix’s CEO and Chairman of the Board.  See link below for a PDF of my more detailed article on Seeking Alpha.


In an alternate universe, there’s a Calix with appropriately lowered expectations, a detailed investor deck, and intact credibility.  It is currently rallying from $6 to $7.50 on the quarter’s results.  People who bought ahead of the quarter are starting to relax and settle in for the ride.  New investors are reading a clear, detailed shareholder letter that focuses on 2020 prospects.  Doing their own math and thinking about buying in.  The deep value folks who’ve supported CALX, feeling good about a job well done, are maybe marking up the price where they’ll start selling off to the growth crowd.

All is well in that alternate universe.

In our reality, we are wallowing in the swells. Engine off.  A windmilling rudder.  Cash is low. Praying a storm doesn’t hit before we get headway again.  The easy excuse is “What can we do if Frontier and Windstream shifted plans on us?”  The answer is You can do plenty right now.

  1. Significantly improve the depth and detail of your disclosures.  What does Calix 2.0 look like?  I have no idea.  Maybe you’ve hinted at it in conference 1-on-1’s.  That sort of selective disclosure isn’t going to work for a $400m cap left-for-dead stock.  Put it on paper and get it out there.
  2. Fix your forecasting and guidance process.  Quarter after quarter we see a reliable skew towards insupportable optimism.  Put on some corrective lenses that aren’t quite so rose colored.  Forecasting is tough, but most companies get it more right than Calix does.  OR at least get it wrong in both directions.
  3. Change your tone.  I wasn’t at the Cowen conference and I have no idea what was said, but [Cowen Analyst] didn’t hang himself with that table-pounding note [ahead of the quarter that drove CALX up to $7.50] unless someone handed him a whole lot of rope.  One more person with singed fingers.
  4. Promote or hire someone with intact investor credibility to add weight to a more sober message.  A credible message still needs a credible messenger.

The above won’t get Windstream and Frontier back to buying, but it would eliminate a massive uncertainty discount.  The weight of that uncertainty depresses the valuation.  It also depresses trading volumes.  The quarter-by-quarter stream of self-inflicted whipsaws only drives people away.

If you shit in your own backyard long enough, people stop coming over.  Other people start writing up the truth for all to see.  Its not a lot of fun for anyone.  So do something to change the situation.

Key messages From The Seeking Alpha Article (link to PDF below or link to website here.)

Calix_ Drifting At The Mercy Of Market Tides – Calix, Inc. (NYSE_CALX) _ Seeking Alpha

My best guess is CALX will drift with the market until we get to the 3Q19 report – probably in mid-October. A decisive turn in the numbers may not come until 2020.

Today’s market reaction just takes CALX back to mid-June 2019 levels. With the stock holding above $6 today, the pre-quarter run up and subsequent drop could be seen as just a blip in an improving trend. But there is damage done.

Calix has singed the fingers of yet another crop of recent buyers who might have been convinced to become long-term holders of the company. Questions left un-answered by management on the 2Q19 call (see below) will also make it that much harder to find new buyers. Investors tend to be wary about crediting improvements in advance after a stock has burned them so frequently and recently. In the meantime, that leaves Calix and its current owners at the mercy of market tides.

I continue to hold the stock. I’ve done enough digging to see through to those improving fundamentals. Per the below, there is still 50%-100% upside on 2020 numbers with more potential in 2021. The question is how long it will take until numbers turn up decisively enough and/or disclosures improve significantly enough for the market to price that in.


At some future date, the numbers will win out. The market will duly price them in. A more forthcoming approach to disclosure would bring that date forward by several quarters. It is mystifying and frustrating that Calix management (and its Board) doesn’t seem to grasp that truth.

Calix produced a 7 page investor letter on July 23. They held a 36 minute call on July 24. Yet they failed to answer some very simple questions that would seem central to analyzing and understanding the stock. I present them below. Their call transcript is here.

Questions Left Un-Answered on the Call.

Calix 1.0 to 2.0 Transition/Trajectory: Calix management it pitching a “Calix 1.0 to Calix 2.0” transition to a higher gross margin, more software-based, more profitable business model. But they have given no detail. What is a reasonable range of margin expectations for Calix 2.0 at maturity? How long to get there? How big are Calix 2.0 products and service as a percent of total revenues today? When will it become a majority of Calix’s revenues? The only comment given on the call was a highly un-specific “our [new] platforms are growing very rapidly, but still off of, let’s say, minority numbers. Our traditional and supporting products or our legacy products are still the large majority of the business.

Composition of the Customer Base That is Actually Growing? Calix did (finally) disclose that CenturyLink, Windstream, and Frontier are down from over ¾ of revenues to “less than ¼.” CenturyLink was 17% of 2Q19 revenues, leaving bankrupt WindStream and struggling Frontier at around 7% combined. So we know who is shrinking. But we know very little about who is growing. Calix gives no detail on the composition of the other 76%+ of its revenues. We know that Verizon and CityFibre are relatively big and growing fast, but we don’t know how big or how fast. We are wholly in the dark on the rest of their customer base. This is particularly frustrating as one of Calix’s great strengths should be its relatively wide customer base among rural telcos, cable companies, electric cooperatives, and new over builders. That diversity could be perceived as a strength if we had some numbers to back it up. The only detail given on the call was “Headwinds from our publicly traded ILEC customers will continue through the third quarter and into the fourth quarter. We are confident that these headwinds will no longer be a meaningful factor in the business entering 2020. It is worth noting that not many years ago, this narrow category of customers represented more than 3/4 of our business. Today, that same set of customers delivers less than 1/4 of our business. The flip side of this story is the robust nature of the future Calix business model. We continue to add new customers at a rate greater than 100 per year. That is remarkable. And as the headwinds from our legacy business subside, this new business will continue to shine.”

Outlook for Verizon and CityFibre? Engagement With Other Potential Marquee Customers? Calix management did provide a significantly more detailed update on marquee customers Verizon and CityFibre (see quote below). It is not clear if they will continue to deliver that much-needed context. Moreover, they continue to provide no insight into engagement with other large potential customers. It is never advisable to count chickens before they are hatched. But it would help to have some rough color on how many eggs are left in the nest that might hatch.

Cash Flow Outlook? As a rule of thumb, telcos like to see about one quarter’s worth of cash (or more) on their supplier’s books as a cushion in the event of a downturn. For Calix, this would amount to about $100-$150m. Net cash at present is about $10m. Calix does seem likely to turn cash positive in 3Q19. It appears to have the continuing support of its lender Silicon Valley Bank (the source of the $25m revolving debt shown on the balance sheet). Calix also has roughly $15-$20m of excess inventory that should convert to cash as its contract manufacturer recovers from its 1H19 production problems. But it doesn’t appear that Calix will be comfortably liquid until well into 2021. Will they be able to finance growth in the meantime? When will shareholders see a cash return on their invested capital?

Internal Management Changes to Address Persistent Forecasting Errors and Operational Failures. In the past three years, Calix has experienced two major operational failures – poorly negotiated, negative margin services contracts that dragged down results for all of 2017 and the more recent disruptive manufacturing shift out of China in 2018-2019. Calix has also persistently failed to set and communicate realistic forecasts and guidance to investors – as evidenced by the jagged path of the stock price. It would seem to behoove the company to 1). Make structural management changes to improve execution going forward. 2). Discuss and disclose those changes so investors might have more confidence in that future execution. As it stands, it is not clear if Calix management even sees a need for structural improvement.

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