Harold ( Hal ) Vogel , Ph.D. , CFA Vogel Capital Management

1. Market Life Lessons: A Fundamental Analyst's Perspective on Bubbles & Entertainment and Travel Sectors. Fordham University March 7, 2017 Harold (Hal) Vogel, Ph.D., CFA Vogel Capital Management

2. To Begin: • Take a look at the following • It’s a second-order stochastic partial differential equation starting with: • We’re going to solve it using Itô’s Lemma!

3. Ha, Ha!

4. This approach is rooted in the efficient market hypothesis. Assumes that arbitrage can be effected quickly and without cost. Assumes that markets are equilibrium-seeking machines. Assumes that traditional neoclassical concepts are true. They’re not. Well, kidding (sort of) because:

5. Neat math – CFA/PhD exam stuff. • In real world, info is asymmetric and imperfect. • LOOP is questionable. BUT: This approach falls apart in the real world, especially in bubbles and crashes – which happen far more often than investors think.

6. Some examples of LOOP Failure: • 3Com/Palm • GM/Hughes Electronics • Royal Dutch/Shell and Unilever • LTCM • Shleifer and Vishny (1997) – Arbitrage constrained by limits on time and capital, making it ineffective in extreme circumstances (i.e., bubbles and crashes).

7. Major Flaw in Market Economics • Financial Markets trade opposite to usual supply and demand schedules and theories of such. • Rising demand might cause the price of beef to rise if supply remains the same. So you might substitute chicken for beef if the price of chicken is relatively lower. • Not true for financial assets in bubbles and crashes because – higher prices generate higher relative demand and falling prices increase supply. (Prechter and Parker (2007).

8. Herding takes over • “Herds are ruled by the majority, not the wise.” • In going against the grain of a bubble by moving to cash or short-selling, "[E]arly looks a lot like wrong.” (Yale’s CIO Swensen) • “You either participate in this mania, or you go out of business. It’s a matter of self-preservation.” (Roger McNammee)

9. “In economic matters, rising prices repel buyers; in investment matters, rising prices attract buyers...In the product marketplace, the consumer wants prices lower while the producer wants them higher…In the world of investments, however, the consumer (who buys it) and the producer (who creates and wants to sell more of it) both want prices higher.” (Prechter, 1999).

10. Bubbles and Crashes: Repeating patterns (1) Japanese real estate price indices, 1990=100

11. Patterns (2) Nasdaq 100, Nasdaq Composite, and S&P 500 indexed weekly (first week of 1995=1.0), January 1995 to December 2002.

12. Patterns (3) Industry sector concentration (yearend) in the S&P 500, sector percent of total market value of S&P 500, 1989-2016

13. Patterns (4) Bubble configurations: S&P Housing Price Index (Bloomberg S5 HOME<index>), 2000 - 2007, weekly, versus S&P Information Technology Index (Bloomberg S5 INFT<index>), 1995 - 2002, weekly.

14. Repeating (5) S&P 500 Index, daily closing prices, 1995-2003 (left scale, dark line) versus Nikkei 225 Index, daily closing prices, 1985-2002 (right scale, light line).

15. Repeating (6) Lesson: Crashes retrace all or most of bubble Shanghai Stock Exchange Composite index, 2013-2017:Q1

16. Prices are much more volatile than earnings and dividends Real S&P price index versus real S&P earnings, Source: Shiller Web site, www.irrationalexuberance.com/ie_data.xls

17. Are We in a Bubble Now??? (1) Total U.S. Federal Debt in $ trillions (right scale) and as a percent of GDP, 1966 to 2016.

18. Bubble Now? (3) WEALTH/PDI CAP/GDP Wilshire 5000 total US market capitalization to US GDP, quarterly, 1970-2016, left, and U.S. total household and nonprofit organizations, total financial assets (wealth) as a percentage of personal disposable income.quarterly, 1960:01 to 2016:02.

19. On Bubbles and Crashes • The EMH and CAPM and LOOP are nice theories, but don’t help you make money in the market. • Bubbles and crashes happen (rather often). • Bubbles occur when there’s more credit/money created than can is needed for real GDP. • Money/credit is created out of thin air by commercial banks via loans. • Money/credit and liquidity evaporate rapidly when trust is impaired.

20. The Fed Follows Three-month market Treasury bill rates (dark line, TB3) versus FOMC Fed funds rates (gray line), January 1985 to December 2016. Source: Federal Reserve Open Market Committee, http://www.federalreserve.gov/fomc/fundsrate.htm

21. Know Your Stuff! Implication: • Understand bubbles & crashes. (Anyone maybe wanna buy a book?) • Get to know your industry’s fundamental features and history. • Accounting methods provide important clues.

22. Entertainment Basics

23. What all media and entertainment businesses provide and sell is…

24. Experiences…and…

25. they traffic in (i.e., trade) in….

26. RIGHTS

27. Some Examples (1)

28. Companies Vigorously Defend Rights • Disney – litigation, the profit center • MCA – senior citizens beware

29. Some Bedrock Characteristics, Caves, 2000 • Demand is highly uncertain as no one knows in advance how consumers will value new products and services (nobody knows) • Most creative products (e.g., paintings) can differ in many ways through small differences (infinite variety) • Option contract forms prevailin creative industries because many of the costs are fixed but also sunk (irrecoverable) at various well-defined stages of production

30. Fat Tails -- Power Law

31. Power Laws Illustrated (1)

32. Hollywood Accounting

33. Power Laws Illustrated (2)

34. Power Laws Illustrated (3) - Sports 2008 Forbes rankings

35. Film Stuff

36. Movie Biz Isn’t What You Think Major film companies are engaged in 5 distinct activities: • Rights Clearinghouse • Financing • Marketing • Distribution • Risk Transference

37. Oh, Studios Make Films Too!

38. Examples (2)

39. Why? • Net profits and profit participations are contingency payments that are bonuses. • Profits are defined by whatever the parties agree to. • Everyone on film got paid in full...what studio owed them…and no checks bounced!

40. Harry Potter & Order of Phoenix, WB, 2007

41. Management forecasts film profits Market format by market Territory by territory Sometimes they goof big-time: -- Disney: John Carter -- Universal: Battleship $200 mm losses Viacom -- Monster Trucks $115 million loss before release!

42. Doesn’t matter! For Disney, $200 mm is 5 days of ESPN

43. Airfares and room demand

44. Airline costs

45. Revenue Passenger Kilometers vs GDP

46. Hotels & GDP

47. RevPar & Lodging stocks Annual average percent changes of monthly S&P lodging share price index versus annual percent changes of lodging industry RevPar, 1980 to 2014.

48. Fun Facts: A decision to trim an ounce from its steaks saved Delta $250,000 a year. Removing a strawberry from salads served in first class on domestic routes saved $210,000 a year. One-cent increase in peanut prices adds $610,000 to costs given that Delta passengers consume 61 million bags of peanuts each year.