Predictions, Free! (and worth every penny)

Back in my Army days, I used to participate in a couple of football pools. It was a simple, pick-the-winners operation, nothing like the sophisticated parlay, cover-the-spread wagering available online now. As a pre-Internet, pre-Xerox operation, it was pretty low-tech, requiring just one person with access to a mimeograph machine (ask your parents) to print up the brackets. None of us was exactly an expert, and I wasn’t especially good at it.

But I knew that there were people who took sports gambling much more seriously than I did and wagered more than just their lunch money on it. And one way I knew this was that I used to see little ads in the back of magazines advertising the services of skilled professionals who offered lists of college and NFL game predictions that were guaranteed to make you money “… or your money back!”

I remember thinking that these guys must be really good, otherwise they’d never make any money. Then I found out that it was all a scam. The tipsters would get the money from big betters and send out their lists of picks. But the picks weren’t all the same! The tipsters would mix their predictions up, keep the money from the subscribers whose picks worked and send back the money from the ones that didn’t. Their real skill wasn’t so much in picking games as it was in calculating how many messages should have the close games picked one way and how many the other. The successful bettors would send in their money again the next week and the ads would bring in new suckers. They couldn’t lose.

I learned two lessons from having this flim-flam explained to me. First, you have to remember that not all of the smart people in the world are on the side of justice and fair play. You may have an impression that criminals, as a group, are stupid. But this impression contains a built-in sampling error. The correctly stated principle should read: “The criminals that get caught, as a group, are stupid.” Some of the smart ones are so good at what they do that you never feel the wallet leave your pocket.

The second lesson is that scammers stay in business. We’ve all received pleas from the sons or wives of deceased African leaders offering us millions of dollars in return for our help in transferring funds out of somewhere or other. Ditto for messages from “eBay,” “CitiBank,” and others sternly instruct us about the need to “verify our account information.” They’re so ridiculous (and frequently in such bad English) that I don’t take them seriously. But some people do.

The Internet makes it possible to send these messages to so many people, that there will always be a few who come across. Often it’s the elderly, who have lost their protective coat of skepticism, or the young who haven’t developed it yet. Frequently the victims are people whose greed gets the better of their judgment.

I don’t have any huge point to make here. I just have a grudging admiration for con artists, three-card monte operators, wallet-drop specialists and all the other low-life’s who work their wiles on the gullible. They have a special place in the ecology of humanity and their ingenuity and efficiency at fleecing marks (for whom I also have a grudging sympathy) is a rewarding area of study (as long as I’m not the mark).

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Global equity markets (and equity investors) had a field day after the U.S. Federal Reserve Board delivered its surprise half-percent rate cuts on September 18. Historians of the market noted that stocks have usually done quite well after two rate cuts, a result that has been confirmed in the present case.

It’s remarkable that the Fed, which controls only one tiny element in the complicated machinery of the U.S. economy, can have so large an effect. But understanding how economies work is a project that can take a lifetime and very smart people are known to disagree violently on the subject. I recently ran across a story about an odd apparatus that was built shortly after World War II that tried to help people understand. (I’m including addresses for a couple of websites that will help you get the picture.)

It was 58 years ago this month that Bill Phillips, a New Zealand economist with training as an engineer, unveiled the Phillips Hydraulic Computer, also known as the MONIAC (Monetary National Income Automatic Computer), or (my favorite) the Financephalograph. These were they days before transistors, and electronic computers were room-sized behemoths with thousands of vacuum tubes. The PHC, by contrast, was a seven-foot-high, five-foot-wide board with clear tanks filled with colored water and connected by plastic pipes. It had only one purpose: to simulate the flow of money in the British economy under differing economic conditions.

A few of these marvels are still around, and here’s how they work. Colored water representing income (the national income) enters a transparent central column at the top of the machine. Part of the income is diverted into a reservoir representing taxes, some goes into savings and some goes into a pipe called imports. (These three represent the uses of income that take money out of the economy.) The rest forms the main flow, which is consumption expenditure. Part of the outflow into taxes rejoins the main flow as government spending. Part of the savings money is put back in as investments. And part of the imports outflow comes back as exports. The main flow, consumer spending, winds up in a tank at the bottom of the machine, from which it is pumped back to the top of the machine as income.

The wonderful thing about Philips’ invention is that its operators can change its settings and then see the results in the machine. Valves can be adjusted to represent changes in taxation rates or savings rates or shifts in the balance of imports and exports. Once the machine is set up and running, it becomes clear, for instance, that if consumers save too much, there will be less money available for spending, and thus less total money in circulation. In a nutshell, the computer uses changes in the flow of water to model the relationships between government taxation/spending, consumer savings/investment, and national imports/exports.

Estimates vary, but even the harshest assessment of the computer’s accuracy put it at around 5%. When properly tuned, one researcher found that it was accurate to 2%. And its value as a teaching aid was enormous. More than a dozen of the machines were built, with four going to universities in Great Britain, two being built for the London School of Economics where Philips was teaching, two to universities in Australia and New Zealand, and single machines going to the Ford Motor Company and the Central Bank of Guatemala.

You can read an excellent description of the machine (and a bit about its inventor) at the website of the New Zealand Institute of Economic Research (Philips was a kiwi, himself) at http://www.nzier.org.nz/Site/about/NZIER_Moniac.aspx. There is also a useful diagram and description at the site of the Computer Conservation Society at http://www.cs.man.ac.uk/CCS/res/res12.htm#e.

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The Cabot China & Emerging Markets Report has been committed to a BRIC strategy for more than a year, paying special attention to the stocks from Brazil, Russia, India and China. We’ve had good results from stocks from all four of these countries, so it’s a little unusual that the Report’s portfolio (currently 80% invested) is made up exclusively of stocks from China.

Maybe it’s not so odd, now that I think of it. China has the most people, the fastest-growing economy and the loudest buzz of any market in the world. Websites and paper publications are filled with articles about the Olympics, pollution, corruption, unparalleled prosperity, political repression, you name it! Accordingly, in the spirit of the old maxim “When you’re on top, the only way to go is down,” I’m paying special attention to Brazil, Russia and India. Anyone can find the last big thing; making big money is about finding the next big thing.

One company that has caught my eye recently is Gafisa (GFA), a Brazilian company that’s trying to bring North American-style housing developments to Brazil. Brazil’s population is more than 70% larger than that of Mexico, but its housing market is about half of that in Mexico. But as prosperity works its way through the Brazilian economy, more and more people will be able to afford homes, and Gafisa is bringing the efficiency of modern building methods to the building process.

Whatever you may think about urban sprawl and real-estate developers in general, you can’t say that they aren’t profitable. 2006 revenues at Gafisa were up 62% from 2005 and earnings per share more than doubled, from 20 cents to 54 cents. Combine this with an after-tax profit margin of 12.1% and the numbers look good, making it clear why institutional sponsorship has almost doubled just from the first quarter of this year to the second.

Another trend working in Gafisa’s favor is geographical growth. Two-thirds of 2006 revenues came from building in the Sao Paulo region, with another 27% from the area around Rio De Janeiro. Now Gafisa is branching out, forming joint ventures with regional builders in the states of Maranhao, Paraiba, Rio Grande do Norte, Ceara and Pernambuco.

And finally, GFA has just been made a part of the Bovespa Index, the Brazilian equivalent of the S&P 500.

Technically, GFA has an interesting chart. The stock came public last March at 24 and ran quickly to 36 at the beginning of June before correcting for a month. It returned to the 36 level in early July, and then took a two-month tumble, plunging to as low as 21 during the infamous August 16 sub prime mortgage panic. But beginning on September 11, the stock began a determined run that has brought it back toward those old highs on good volume. Eventually, I look for a breakout above 36 into new-high territory.

GFA has exactly the kind of triple threat I like to see in a stock: a good story, strong fundamentals and a chart that reflects some enthusiasm from investors. I think it’s worth a look.

Paul Goodwin
For Cabot Wealth Advisory

Editor’s Note: The Cabot China and Emerging Markets Report was the top-performing newsletter of 2006 with a profit of 75%, and is still in the lead over the most recent twelve months. Brazil, Russia, India and China all have high-revving economies that are powering companies with incredible growth. If you would like a proven ally to help you with investing in this fast-moving world, the China & Emerging Markets Report may be just the ticket. To get started with a no-risk trial subscription, click on the link below.

http://cabotmail.net/t/263946/13736724/121/0/

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