Yesterday's decision by the Federal Reserve to "do nothing" has given us a swooning stock market today. Why? Because the Fed's indecision to do the right thing (i.e. raise interest rates) is a signal of lack of will to the financial markets. Not surprisingly, financials held ground yesterday, while industrials dipped, and commodity-related securities rallied in the face of more inflation. Today oil topped $140/barrel due to a weaker dollar, and combining the United States' lack of will to find its own oil reserves, the U.S. market has fallen.
Imagine that the market is a coiled spring that has been wound down to the floor by the heavy weight of negative sentiment, inflation expectation, high oil prices, a weak dollar, a weak economy, and an impending dead-heat Presidential election in which one candidate espouses higher taxes, and the other does not (leading to much market uncertainty). This is all bad, right? Yes, and now it's all baked into the current stock market pricing mechanism. Any improvements on any of these fronts will lead to a higher stock market. In particular, a Fed willing to combat inflation through monetary policy would be welcomed by the market, and we would experience market rallies, even with an added threat to the banking system.
Part of the value of dispensing financial advice is not just about "what to do", but sometimes more often "what not to do". Selling into a weak market is a "no-no". There may be some exceptions to this, but they are rare. Buying into a weak market is a "yes" provided an investor has a long term perspective. So for anyone sitting on the sidelines, it's time to start picking at this market, buying temporarily weak sectors or high-quality out-of-favor companies at low prices.
If you have friends that are paralyzed by this environment, have them give us a call. This type of environment is typically when we receive the most referrals.
Thursday, June 26, 2008
Wednesday, June 4, 2008
Politics As Unusual
Well, here we are. Barack Obama has just killed the Clinton political machine, and is now the presumptive Democratic nominee. The battle is now on for the political "center" between John McCain and Barack Obama. McCain is "experienced"; Obama is "shiny and new".
I usually attempt not to proselytize about my own views, but rather to give a likely view that could have *big* consequences for the U.S. economy, taxes, investments, U.S. entitlement programs, and foreign policy.
This November of 2008 is a tremendous tipping point for our beloved nation. This election gives us an opportunity to actually solve some tremendous structural problems in our country. So when you're listening to speeches, reading papers, and making your decision, look for honest debate and concern for the following topics...
1) Comprehensive Energy Policy which focuses opening the floodgates of America's economy to solve our energy reliance. 30 year depreciation and huge tax incentives would be a good start here, and the government should *not* choose which technology wins. The market needs to figure it out. A true solution will focus on new supplies of oil AND new technologies. It's not an either/or option.
2) Entitlement Reform for Social Security, Medicare, Government Pension Plans. These plans need to be fixed ASAP, since we're running out of time, our greatest ally. Kicking the can down the road only robs us of time. There are many countries that have solved their similar problems, but we can't do it here? Failure to act threatens to continue to browbeat our currency, affect our Treasury markets, and could erode our standard of living over time.
3) Taxes. Marginal Tax Rates which stay low, or introduce a Flat tax. Dividend and Capital Gains taxes need to remain low. Raising taxes is the death knell for growth, innovation, and morale.
4) Foreign Policy. Like it or not, 2008 is yet another referendum on the Bush Doctrine. People forget that we already experienced one of these in 2004.
I usually attempt not to proselytize about my own views, but rather to give a likely view that could have *big* consequences for the U.S. economy, taxes, investments, U.S. entitlement programs, and foreign policy.
This November of 2008 is a tremendous tipping point for our beloved nation. This election gives us an opportunity to actually solve some tremendous structural problems in our country. So when you're listening to speeches, reading papers, and making your decision, look for honest debate and concern for the following topics...
1) Comprehensive Energy Policy which focuses opening the floodgates of America's economy to solve our energy reliance. 30 year depreciation and huge tax incentives would be a good start here, and the government should *not* choose which technology wins. The market needs to figure it out. A true solution will focus on new supplies of oil AND new technologies. It's not an either/or option.
2) Entitlement Reform for Social Security, Medicare, Government Pension Plans. These plans need to be fixed ASAP, since we're running out of time, our greatest ally. Kicking the can down the road only robs us of time. There are many countries that have solved their similar problems, but we can't do it here? Failure to act threatens to continue to browbeat our currency, affect our Treasury markets, and could erode our standard of living over time.
3) Taxes. Marginal Tax Rates which stay low, or introduce a Flat tax. Dividend and Capital Gains taxes need to remain low. Raising taxes is the death knell for growth, innovation, and morale.
4) Foreign Policy. Like it or not, 2008 is yet another referendum on the Bush Doctrine. People forget that we already experienced one of these in 2004.
Thursday, April 10, 2008
A Crazy Start to '08
What an ugly start to the year. January was bad, just continuing the bloodshed from the end of 2007. February and March weren't much better. However, we experienced two important psychological bottoms in January and in March, which will help the market re-establish and gain its footing.
The first important bottom occurred the Tuesday after MLK, Jr. day, after a weekend in which all other major markets globally had sold off on Monday (when the U.S. market was closed). So here's this psychological agony going on over the weekend, the overnight futures markets showed the market down 600 in overnight trading, and you know what I was doing?: Licking my chops, and I couldn't wait to get into the office to start buying strong companies at give-away prices; after all, this is my job, right? I get paid to be the calm guy and to buy companies when there's blood in the streets.
The thing I hadn't counted on was the Fed, which decided that nobody is allowed to experience any pain anymore. The Fed aggressively lowered rates, lowered the discount rate, and started printing money, injecting liquidity into the banking system at a clip I've never seen before. The market opened down about 550, and within 30 minutes of the Fed's action, about 350 of that juicy fat-pitch down the middle of the plate disappeared back to the upside. I managed to do some buying that day, but not to the extent that I wished to benefit my Clients. Can't an investment manager be allowed (for just 1 day, please Uncle Ben!) to do his job? Frustrating.
The next psychological bottom came on March 7 (Friday), and March 10 (Monday). This of course was the weekend that Bear Stearns went from a market cap of $2.8 Billion on Friday to being sold for $286 Million on Sunday evening to JP Morgan. The firesale was brought about to effectively "bail out" Bear Stearns, with the Fed's help in guaranteeing certain aspects of the deal. It is thought that a failure of Bear Stearns could have unraveled the financial system. Oh, is that all?! Anyway, it was a sweetheart deal for JP Morgan, which saved the financial system that weekend; interestingly, it was J.P. Morgan himself who bailed out the stock exchange about 100 years ago...
With the Fed in a very generous mood to print money, assuage investors, and stem the panic, the market is getting its legs back. There is still a great deal of uncertainty in the market, and pessimism, but this pessimism is temporal; this is the time to be buying quality companies at low valuations. Investors with appropriately long time frames should enjoy nice returns using this strategy, while the speculators are running scared. The longer term negatives that are concerning: inflation is rising, growth is low or stalled, the dollar is weak, and the Fed can only do so much. In fact, we're at the point now where the Fed has little flexibility to do anything should another shoe drop (financial crisis, terrorism, etc.). Congress needs to do its part and *structurally* add incentives for investors to invest by lowering taxes, and control spending, most importantly on our entitlement programs!
The first important bottom occurred the Tuesday after MLK, Jr. day, after a weekend in which all other major markets globally had sold off on Monday (when the U.S. market was closed). So here's this psychological agony going on over the weekend, the overnight futures markets showed the market down 600 in overnight trading, and you know what I was doing?: Licking my chops, and I couldn't wait to get into the office to start buying strong companies at give-away prices; after all, this is my job, right? I get paid to be the calm guy and to buy companies when there's blood in the streets.
The thing I hadn't counted on was the Fed, which decided that nobody is allowed to experience any pain anymore. The Fed aggressively lowered rates, lowered the discount rate, and started printing money, injecting liquidity into the banking system at a clip I've never seen before. The market opened down about 550, and within 30 minutes of the Fed's action, about 350 of that juicy fat-pitch down the middle of the plate disappeared back to the upside. I managed to do some buying that day, but not to the extent that I wished to benefit my Clients. Can't an investment manager be allowed (for just 1 day, please Uncle Ben!) to do his job? Frustrating.
The next psychological bottom came on March 7 (Friday), and March 10 (Monday). This of course was the weekend that Bear Stearns went from a market cap of $2.8 Billion on Friday to being sold for $286 Million on Sunday evening to JP Morgan. The firesale was brought about to effectively "bail out" Bear Stearns, with the Fed's help in guaranteeing certain aspects of the deal. It is thought that a failure of Bear Stearns could have unraveled the financial system. Oh, is that all?! Anyway, it was a sweetheart deal for JP Morgan, which saved the financial system that weekend; interestingly, it was J.P. Morgan himself who bailed out the stock exchange about 100 years ago...
With the Fed in a very generous mood to print money, assuage investors, and stem the panic, the market is getting its legs back. There is still a great deal of uncertainty in the market, and pessimism, but this pessimism is temporal; this is the time to be buying quality companies at low valuations. Investors with appropriately long time frames should enjoy nice returns using this strategy, while the speculators are running scared. The longer term negatives that are concerning: inflation is rising, growth is low or stalled, the dollar is weak, and the Fed can only do so much. In fact, we're at the point now where the Fed has little flexibility to do anything should another shoe drop (financial crisis, terrorism, etc.). Congress needs to do its part and *structurally* add incentives for investors to invest by lowering taxes, and control spending, most importantly on our entitlement programs!
Thursday, March 6, 2008
Mr. Bernanke's Broadside
See below OpEd from today's Wall Street Journal, 3/06/08, which only underscores our blog commentary from yesterday calling Ben Bernanke an "anti-capitalist"...
Bernanke's 'Principal'March 6, 2008; Page A14
We've seen some puzzlers over the years, but we'll admit we never expected to see a Federal Reserve Chairman talking down the capital cushion of the nation's banking system.
But there it was on Tuesday, the equivalent of a CEO shorting his own stock, as Ben Bernanke encouraged the nation's bankers to write down the principal on millions of mortgage loans. Voluntary loan modifications aren't doing enough to stop foreclosures, declared the chief steward of the U.S. financial system. "In this environment," he said, "principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."
Mull over that one for a moment. Mr. Bernanke and the Fed are charged with protecting the soundness of the banking system. The bulwark of such protection is shareholder equity -- capital -- which is generated in part by income-producing assets known as loans. Yet the Fed chief has now advised that, as a matter of public policy, banks should take a chunk of that capital and transfer it to mortgage debtors. How this additional charge -- and new political risk -- against bank earnings will ease the mistrust at the heart of the current credit crisis is a mystery.
This came only a few days after Mr. Bernanke had publicly advised Congress that more banks will fail. And it came on the same day that the Fed's Vice Chairman, Donald Kohn, told Capitol Hill that bank earnings are under increasing pressure. Amid such earnings strain and uncertainty about how far real-estate prices will fall, now seems an especially bad time for a Fed chief to instruct banks to create further losses.
It's not as if bankers don't understand their mortgage predicament, or have no sympathy for borrowers. But how, and whether, to renegotiate their loan contracts is a matter for them to decide. They might choose to lower the interest rate on some mortgages, reduce the principal amount on others, or foreclose and repossess homes on the hopeless cases. If the Fed, in its regulatory role, thinks a bank should be more aggressive in taking asset write-downs, it can order that on a bank by bank basis. Elevating principal write-downs to a general banking principle is regulatory overreach.
Only the day before Mr. Bernanke dropped his bomb, Treasury Secretary Hank Paulson disclosed that "since July more than one million struggling homeowners received a workout -- either a loan modification or a repayment plan that helped them avoid foreclosure." In January alone, there were 167,000 such modifications, with the number of borrowers receiving help rising faster than the number of foreclosures.
Mr. Bernanke's broadside might well hamper these voluntary workouts by signaling to other borrowers that they needn't do anything at all. They can merely sit tight and wait for their banker to tell them they don't owe nearly as much as they thought. Or they'll conclude they can wait for Congress to provide its own mortgage bailout, this time on the backs of taxpayers who decided not to speculate on real estate during the housing bubble, or not to purchase a more expensive home than they could afford.
It's no coincidence that one of the chief advocates of a government mortgage bailout, House Financial Services Chairman Barney Frank, hailed Mr. Bernanke's remarks as an endorsement. Meanwhile, Mr. Paulson had to wonder why Mr. Bernanke was undermining the Treasury Secretary's sensible public opposition, expressed on Monday, to a taxpayer rescue. Do the gentlemen not like each other?
The worst irony here is that the mortgage crisis is in large part the fault of the Fed's own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been, and the first step in any recovery is letting those now-falling prices find a new bottom. Government interference in that price discovery will only prolong the crisis, increasing the chances that the losses are eventually dumped onto taxpayers.
The government is already well down this road with its expansion of the Federal Housing Administration's authority, and its unleashing of an unreformed Fannie Mae and Freddie Mac. Given his ostensible independence, the Fed Chairman is supposed to be a crucial restraint on all of this moral hazard and political panic. If the Fed can't do that, we might as well let Congress run the banking system.
Bernanke's 'Principal'March 6, 2008; Page A14
We've seen some puzzlers over the years, but we'll admit we never expected to see a Federal Reserve Chairman talking down the capital cushion of the nation's banking system.
But there it was on Tuesday, the equivalent of a CEO shorting his own stock, as Ben Bernanke encouraged the nation's bankers to write down the principal on millions of mortgage loans. Voluntary loan modifications aren't doing enough to stop foreclosures, declared the chief steward of the U.S. financial system. "In this environment," he said, "principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."
Mull over that one for a moment. Mr. Bernanke and the Fed are charged with protecting the soundness of the banking system. The bulwark of such protection is shareholder equity -- capital -- which is generated in part by income-producing assets known as loans. Yet the Fed chief has now advised that, as a matter of public policy, banks should take a chunk of that capital and transfer it to mortgage debtors. How this additional charge -- and new political risk -- against bank earnings will ease the mistrust at the heart of the current credit crisis is a mystery.
This came only a few days after Mr. Bernanke had publicly advised Congress that more banks will fail. And it came on the same day that the Fed's Vice Chairman, Donald Kohn, told Capitol Hill that bank earnings are under increasing pressure. Amid such earnings strain and uncertainty about how far real-estate prices will fall, now seems an especially bad time for a Fed chief to instruct banks to create further losses.
It's not as if bankers don't understand their mortgage predicament, or have no sympathy for borrowers. But how, and whether, to renegotiate their loan contracts is a matter for them to decide. They might choose to lower the interest rate on some mortgages, reduce the principal amount on others, or foreclose and repossess homes on the hopeless cases. If the Fed, in its regulatory role, thinks a bank should be more aggressive in taking asset write-downs, it can order that on a bank by bank basis. Elevating principal write-downs to a general banking principle is regulatory overreach.
Only the day before Mr. Bernanke dropped his bomb, Treasury Secretary Hank Paulson disclosed that "since July more than one million struggling homeowners received a workout -- either a loan modification or a repayment plan that helped them avoid foreclosure." In January alone, there were 167,000 such modifications, with the number of borrowers receiving help rising faster than the number of foreclosures.
Mr. Bernanke's broadside might well hamper these voluntary workouts by signaling to other borrowers that they needn't do anything at all. They can merely sit tight and wait for their banker to tell them they don't owe nearly as much as they thought. Or they'll conclude they can wait for Congress to provide its own mortgage bailout, this time on the backs of taxpayers who decided not to speculate on real estate during the housing bubble, or not to purchase a more expensive home than they could afford.
It's no coincidence that one of the chief advocates of a government mortgage bailout, House Financial Services Chairman Barney Frank, hailed Mr. Bernanke's remarks as an endorsement. Meanwhile, Mr. Paulson had to wonder why Mr. Bernanke was undermining the Treasury Secretary's sensible public opposition, expressed on Monday, to a taxpayer rescue. Do the gentlemen not like each other?
The worst irony here is that the mortgage crisis is in large part the fault of the Fed's own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been, and the first step in any recovery is letting those now-falling prices find a new bottom. Government interference in that price discovery will only prolong the crisis, increasing the chances that the losses are eventually dumped onto taxpayers.
The government is already well down this road with its expansion of the Federal Housing Administration's authority, and its unleashing of an unreformed Fannie Mae and Freddie Mac. Given his ostensible independence, the Fed Chairman is supposed to be a crucial restraint on all of this moral hazard and political panic. If the Fed can't do that, we might as well let Congress run the banking system.
Tuesday, March 4, 2008
Anti-Capitalist Running The Federal Reserve?
In case you missed it, Ben Bernanke, current Chairman of the United Socialist Soviet Republic Federal Reserve, has recommended that "government and private entities cooperate" in reducing some of the stresses on homeowners whose home equity may have dropped in the mortgage meltdown.
http://www.bloomberg.com/apps/news?pid=20601103&sid=aLPiHQ.ASN48&refer=us
Specifically, Bernanke is asking banks to "forgive" some portion of the mortgages held by the banks so that consumers might have some home equity left, presumably to prevent their walking away from their homes (which would prevent even more foreclosures). However, the most likely effect would be (presuming that these same homeowners arent' great at math) that they would simply tap their remaining lines of credit and buy more TV's, home appliances, and pay off credit card debt.
Let's play the logic game. Who is "government"? Eventually that will end up being you and me, and we will pay to subsidize other people's foolishness. Who are "private entities"? These are the banks who participated in creating mortgage contracts with people to purchase their homes. If the banks were to take Bernanke's idea to heart, credit will freeze up even further, which further exacerbates the crisis! So let's get this straight: consumers who financed high priced homes with adjustable rate mortgages, or negative amortization mortgages, and fudged their documentation using "no doc" loan papers (where they pay a higher rate without income verification, but then take the teaser ARM or Negative Amortization rates), need to be bailed out collectively by those "mean sinister banks" and by those "kind generous smart U.S. citizens" who try to spend less than they earn? No. Way. The quickest and most efficient way out of this mess is to let the market actually "work", which means prices need to fall enough for buyers to buy homes again (note to Bernanke: in economics this is called pricing equilibrium).
As far as I'm concerned, Bernanke is a collectivist anti-capitalist. This idea reeks of desperation, of Fed muddling, of having no policy flexibility, and attacks the banking system even further. This is anti-capitalist, and applies Socialist/collectivist solution sets to problems. These solution sets only give more incentive for consumers in the future to make bad choices, and should be avoided at all costs. But instead of just ripping the band-aid off the wound, Bernanke likes to slowly pull it off, taking off one hair and one skin cell at a time.
http://www.bloomberg.com/apps/news?pid=20601103&sid=aLPiHQ.ASN48&refer=us
Specifically, Bernanke is asking banks to "forgive" some portion of the mortgages held by the banks so that consumers might have some home equity left, presumably to prevent their walking away from their homes (which would prevent even more foreclosures). However, the most likely effect would be (presuming that these same homeowners arent' great at math) that they would simply tap their remaining lines of credit and buy more TV's, home appliances, and pay off credit card debt.
Let's play the logic game. Who is "government"? Eventually that will end up being you and me, and we will pay to subsidize other people's foolishness. Who are "private entities"? These are the banks who participated in creating mortgage contracts with people to purchase their homes. If the banks were to take Bernanke's idea to heart, credit will freeze up even further, which further exacerbates the crisis! So let's get this straight: consumers who financed high priced homes with adjustable rate mortgages, or negative amortization mortgages, and fudged their documentation using "no doc" loan papers (where they pay a higher rate without income verification, but then take the teaser ARM or Negative Amortization rates), need to be bailed out collectively by those "mean sinister banks" and by those "kind generous smart U.S. citizens" who try to spend less than they earn? No. Way. The quickest and most efficient way out of this mess is to let the market actually "work", which means prices need to fall enough for buyers to buy homes again (note to Bernanke: in economics this is called pricing equilibrium).
As far as I'm concerned, Bernanke is a collectivist anti-capitalist. This idea reeks of desperation, of Fed muddling, of having no policy flexibility, and attacks the banking system even further. This is anti-capitalist, and applies Socialist/collectivist solution sets to problems. These solution sets only give more incentive for consumers in the future to make bad choices, and should be avoided at all costs. But instead of just ripping the band-aid off the wound, Bernanke likes to slowly pull it off, taking off one hair and one skin cell at a time.
Tuesday, February 12, 2008
Investing in Uncertain Times
Amid the subprime mortgage fallout, the U.S. housing market has seen a marked drop in demand, higher levels of unsold inventory, and an increase in foreclosures. Media coverage of these events seems to emphasize that the fallout is unclear, that conditions may worsen, and that the total impact will not be known for some time.
These are precisely the conditions to engage in contrarian investing. At this point of the investment cycle, the valuations of select companies are very attractive, meaning that their current market valuations are trading below their intrinsic values. Examples abound in the financial sector, pharmaceutical sector, auto sector, and food sector. It's understandable for Clients to wonder whether purchases in these areas are "too early", given the potential for continued deterioration, especially in currently unpopular sectors of the economy. How can we determine fair values for companies when the total impact of such current events may be still unknown?
In difficult times stock prices tend to exaggerate the prevailing uncertainties. Opportunities are created where individual stock prices fall below a rational assessment of business worth. Keep in mind that an assessment of business value is conservative and not precise; intrinsic value estimates are dynamic. Often it is best to describe intrinsic value estimates as a "neighborhood", not as specific address. Reversion to the mean allows us to take advantage of short-term price declines that can create long-term opportunities. When the relative difference between stock price and assessed fair value is great enough, the investment decision is not dependent on precision.
These are precisely the conditions to engage in contrarian investing. At this point of the investment cycle, the valuations of select companies are very attractive, meaning that their current market valuations are trading below their intrinsic values. Examples abound in the financial sector, pharmaceutical sector, auto sector, and food sector. It's understandable for Clients to wonder whether purchases in these areas are "too early", given the potential for continued deterioration, especially in currently unpopular sectors of the economy. How can we determine fair values for companies when the total impact of such current events may be still unknown?
In difficult times stock prices tend to exaggerate the prevailing uncertainties. Opportunities are created where individual stock prices fall below a rational assessment of business worth. Keep in mind that an assessment of business value is conservative and not precise; intrinsic value estimates are dynamic. Often it is best to describe intrinsic value estimates as a "neighborhood", not as specific address. Reversion to the mean allows us to take advantage of short-term price declines that can create long-term opportunities. When the relative difference between stock price and assessed fair value is great enough, the investment decision is not dependent on precision.
Tuesday, January 22, 2008
January Was Named for Janus
Janus, a God during Roman times, had two faces looking in two different directions, and boy has he been playing rough this month! Unfortunately the direction of the markets in January has been the down, down, down direction. Again we've seen earnings weak in the financial sector, with more and bigger writedowns from the credit crisis.
The credit crisis that we've seen unfold in the last several months has occurred due to lack of faith in how assets were priced in the mortgage market, collateralized debt obligation market, the collateralized mortgage obligation market, etc. Basically, because the "faith" aspect vanished, the market for these securities vanished with it, and with no one on the buy side of the equation, the banks and investment banks have been forced to "write down" the value of these securities, and *still* the valuations of these securities is questionable.
Our best guess as to what will happen is that there needs to be capitulation by CEO's! Yes, the CEO's, who are embarrassed and fighting for their jobs with the Boards of their companies, will need to *aggressively* write down assets each quarter as they "mark to market" the values of these securities. What will eventually happen is that the writedowns will be so big as to be actually conservative on the down side; in which case all the bad news will be out, the credit market will price this information in, valuations will improve, and then all of a sudden the banks will *re-state* a prioir quarter TO THE UPSIDE. When this happens 2 or 3 times with the banks, that will signal the bottom in the financials.
The credit crisis that we've seen unfold in the last several months has occurred due to lack of faith in how assets were priced in the mortgage market, collateralized debt obligation market, the collateralized mortgage obligation market, etc. Basically, because the "faith" aspect vanished, the market for these securities vanished with it, and with no one on the buy side of the equation, the banks and investment banks have been forced to "write down" the value of these securities, and *still* the valuations of these securities is questionable.
Our best guess as to what will happen is that there needs to be capitulation by CEO's! Yes, the CEO's, who are embarrassed and fighting for their jobs with the Boards of their companies, will need to *aggressively* write down assets each quarter as they "mark to market" the values of these securities. What will eventually happen is that the writedowns will be so big as to be actually conservative on the down side; in which case all the bad news will be out, the credit market will price this information in, valuations will improve, and then all of a sudden the banks will *re-state* a prioir quarter TO THE UPSIDE. When this happens 2 or 3 times with the banks, that will signal the bottom in the financials.
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