Wednesday, July 31, 2013

From Butterfly Wings to ObamaCare

If a Monarch butterfly flaps its wings in Mexico, how does it affect the weather in Virginia Beach?

A group of bright young mathematicians, econometricians, and old-fashioned computer nerds from MIT started a little company called Hidden Levers which looks at the quantitative relationships between many, many things.  Their goal is to predict the impact on individual portfolios from some exogenous shock, such as a credit downgrade for the U.S, for example.

My portfolio here could be affected by a change far away, and I want to know about it.  If a change in Factor A causes a change in Factor B, which causes a change in Factor C, then we know that a change in Factor A causes a change in Factor C.  When there are about 30 thousand factors, even a computer can get a headache!  Their computer program is capable of crunching about 2 million numbers daily -- without Excedrin!

They have now studied the impact of Obamacare under three different scenarios.  Quoting them, "if successful, Obamacare will make the USA more competitive by lowering health care costs."  In that case, they and their incredible computer expect the S&P 500 will rise 15% over the next year.

Continuing to quote them, "Obamacare will fail if costs balloon, causing a drag on the GDP growth."  In that case, the computer expects the S&P to drop 10% over the next year.

The worst case is "if attempts to defund the ACA [Affordable Care Act or Obamacare] force a government shutdown, the US risks a replay of the fiscal cliff -- and it's difficult for the Fed to step up further."  In that worst case scenario, they expect the S&P would drop 14%.

I do not detect any political bias at Hidden Levers.  They acknowledge that Obamacare is not what Obama wanted.  (He wanted universal healthcare or a single-payer system.)  This is not what the Republicans wanted either.  Maybe, we should call it "FrankenCare."  Regardless, we seem to be stuck with it, and I don't want my portfolio to suffer because of it.

However, neither the computer program nor the analysis by Hidden Levers touches on the long-term consequences of Obamacare.  Even a computer cannot see more than a year into the future, I guess . . .

Tuesday, July 30, 2013

Great News + Good News = Bad News

Four times a year, corporations are required to state their earnings.  This is called the "earnings season" or the "confession period."  Before the companies make their announcement, analysts at various investment firms predict what those earnings will be.  The expectations of the analysts are usually priced into the current price of the company stock before the earnings announcement.  If the corporation does better than analysts expect, the stock usually rises.  If not, it falls.

So far this earnings season, 68% of the corporations have beaten analyst expectations of earnings-per-share (EPS), which is great news.  Two out of three companies did better than expected, on an EPS basis.

The good news is that 56% of the corporations beat the revenue estimates of analysts.  Total revenue is the top line of an income statement.  EPS is the bottom line.

So, bottom line earnings is growing faster than total sales or revenue.  This has been an ongoing "problem" in the market.  Why aren't sales rising faster?  The stock market is reacting less to EPS growth and more to revenue growth, which is a better economic indicator than EPS anyway.

In the face of slow sales growth, companies can increase earnings by decreasing expenses or improving productivity.  Hiring more people is not in their game plan, and that is bad news.  

Thursday, July 25, 2013

The Vampire Squid Spews

Despite their reputation, I think Goldman Sachs has an excellent research department.  Here are some of their latest thoughts:

1.  Our GDP growth rate of about 1.6% will double next year.  (This would be huge!)
2.  Inflation is not on the horizon, due to slack labor and weak commodities.  (Why wouldn't it be affected by such strong GDP growth?)
3.  Fed tapering of QE will be announced in September & start in Q2 of next year.  (Remember the hissy fit the market had to Bernanke's press conference in late May?  It fell all June because it was panicked over reducing the monthly amount of QE or bond buying.)
4.  The S&P will end the year at 1,750 or up another 3%.  (That would NOT be huge, but why wouldn't it be impacted by the September announcement of QE tapering?)
5.  Long term interest rates rising a quarter point next year and a full point by 2016.  (Due to growth or to Fed action?)
6.  Despite large deficits, the dollar will not weaken, due to rising interest rates in U.S.  (But, our American exporters want the dollar to weaken.)
7.  Gold remains flat at $1,200 past 2015.  (That assumes no inflation and no growth in India & China.)

I was disappointed they didn't discuss the impact on the market from the debt ceiling debate in October nor our continuing vulnerability to Europe.  But, maybe, that is the message:  that the U.S. economy will be fine, as long as we operate in a vacuum, separated from the world . . . and from Washington.

Monday, July 22, 2013

Watching A Dinosaur Die ?

Years ago, I was asked by my employer to consider a transfer to a newly-created hedge fund department, and I'm so glad I did not do so.

After World War II, an Australian journalist in New York wanted to create an investment fund that was "hedged."  In other words, the fund would retain its value regardless of whatever the stock market did.  This is sometimes called an "absolute return fund."  (He did this by shorting each stock he owned.)

Over time, hedge funds developed eleven different strategies for making money.  By far, the two most profitable strategies were macro and arbitrage.  The macro strategy depended heavily on either inside information or advance information.  Changes in SEC regulation in 2000 made this much more difficult and penalties much more severe, reducing profitability for that strategy.  In addition, the arbitrage strategy depends on market inefficiencies, such as a temporary difference on a stock on the New York Stock Exchange and the Tokyo Stock Exchange.  When the market moved to decimalization, the differences per share were reduced from 12.5 cents per share to only one cent per share, and profits of this strategy also disappeared.

Only wealthy investors are allowed into hedge funds, because the SEC assumes they have enough money to hire intelligent advisors and can also afford to lose their money.  Currently, wealthy investors have poured $2.3 TRILLION into about 8,400 different hedge funds.  After all, it is obligatory for wealthy investors to mention they are hedge fund investors at cocktail parties, isn't it?

But, are they still good investments?  Well, so far this year, hedge funds have been beaten by the plain, old-fashioned stock market by over 10%.  This is huge!  At the same time, their fees of 2% annually and 20% of the growth are horrendously high.  Their investment edge has steadily eroded over the years.  Today, Bloomberg describes them as glorified mutual funds for the rich -- that under-perform the market.  Rich people get to pay extra for less performance.

Are hedge funds dinosaurs?  Of course not!  They will be around for a very long time, but we will know they are finally dinosaurs when we see people at cocktail parties brag that they avoid hedge funds.

Saturday, July 20, 2013

The Joy of Air Travel

If there is anything good about the soul-numbing hassle of air travel, it is the opportunity to catch up on your reading.  On my trip last week, I read eight different trade journals on the market and was struck by the uniform "wall-of-worry."  It was depressing.  Yes, the sky may be falling but is it falling today?

While it sounds like Warren Buffett, I'm not sure who asked why we obsess over the problems we do know, and we ignore solutions we don't know.  I know that sounds like blind faith that we can always deal with problems when they develop, but stranger things have happened.  For example, Ben Bernanke has done things nobody ever tried before.  Is there nobody else out there who will try things that have never been tried before?

After all, there are many things that can go wrong landing an airplane, like wind sheer, collapsed wheels, electrical fires, etc.  I have no idea how the pilot would react to those problems, but I have confidence an experienced professional pilot will try everything he can to land the plane safely.  Would my worrying help him land the plane?

No airline passenger or investor needs to read eight different trade journals to know there is another bear market coming.  There is always another one out there, somewhere in our future!  While I suspect the next one will be sudden, it does not mean I should be afraid.  Would my worrying prevent it?

The joy of air travel is that it reminds us to be somewhat trusting.  The job of investing is that it reminds us to always keep our trigger finger near the SELL button . . . just in case.

The conventional wisdom is that an investor should "buy and hold," and there are numerous scholarly articles on how investors tend to sell after the peak and buy after the trough.  That's the problem with conventional wisdom, it is too conventional.  Bear markets will be more sudden and more severe in the future, but that's unconventional wisdom.  So is keeping your trigger finger near the SELL button!

Friday, July 19, 2013

Nuff Said

The camaraderie that exists in the military is unlike any other.  In particular, I miss the deep beer-soaked  philosophical discussions with my fellow young, inexperienced, infantry lieutenants.  Such discussions usually ended in one of two ways, i.e., hilarity or moroseness.  Most often, we ended with the hilarity that everything we said or did was hysterically funny.  Sometimes however, we became morose and reflected on the deadly business we were trained to complete.

A common subject was what command would we give if we were hopelessly over-powered by the enemy.  Universally, we felt our final command to the troops would be ATTACK, hoping to go out in a glorious hail of gunfire and hopefully taking some of those "sorry bast__ds" with us!

After all, that was entirely consistent with our high school coaches whose mantra was "the best defense is a good offense."  And, are coaches ever wrong?

So, what would I do if I found myself being followed at night by a "crazy-ass cracker" or anybody else, who has a gun and has the drop on me?  If I believed he only wanted to rob me, I would probably comply, unless I felt I could overwhelm him somehow.  If I believed he planned to kill, I would absolutely ATTACK and hope for the best.  Isn't that what the Army taught me?  Isn't that what my high school coaches taught me?

Barry Goldwater once said "extremism in defense of liberty is no vice."
Extreme measures in defense of my physical liberty is also no vice.
Attacking an attacker is no vice.

Thursday, July 18, 2013

If History Matters

I keep returning to this graph.  It bothers me!  I do believe history is a good guide to the future -- but only until it isn't.  History is less important in a society where the rate of change is increasing.  But first, take a few minutes to study this graph:

Chart of the Day

In the last 112 years, the Dow has fallen 30% or more thirteen times.  This chart measures the strength of each recovery.  Currently, we are sitting at record highs despite being a relatively weak recovery.  This tells me that it is unimportant that we are at record highs -- there is still lots of upside for the market.

Generally speaking, the greater the bear market, the greater the bull recovery.  In other words, we didn't suffer a mere 30% decline in the Dow during 2008/9.  We fell a whooping 52%, suggesting our current recovery should be stronger than average.  But, obviously, it is not.

If history is a guide, we're entitled to a stronger stock market recovery than we're getting!

One difference in our current history is that we are now more globalized than ever, and the rest of the world is growing more slowly.  Another difference is that we now have a dysfunctional political model.  

So, all we need to do is fix Europe and fix Washington, right?  Piece of cake!

Tuesday, July 16, 2013

Existential Calvinism ?

Today's news carried a story about the benefit of working past normal retirement age.  It cited a French study that each additional year of work decreased our probability of getting dementia by 3.2%.  All I could say was . . . surprise, surprise?

Recently, a good friend said I was becoming positively Calvinistic in my zeal for advocating work as good and healthy.  He knows I believe work is its own reward, just as education is its own reward.

(But, first, I wondered what is an existential Calvinist anyway?)

More importantly, Calvin is obviously attributed to John Calvin (1509-1564), whose teachings mostly involved the theological issues of Predestination and Free Will, which led to the establishment of the Presbyterian Church.  However, a side issue during that debate was usury, i.e., whether Christians could charge interest for loans.  Calvin came down clearly on the side of business -- that it was permissible to charge interest.  This had a positive impact on capitalism, and Calvinism developed a reputation for being business-friendly.

As capitalism blossomed, Presbyterian churches were among the first to realize church members were more likely to give more money to the church, if the members worked harder in their jobs.  Again, this helped capitalism, sealing the perception that Calvinism was pro-business.  So, it is understandable that anybody who advocates the benefits of work could easily be seen as Calvinistic.

Personally, my zeal comes from the real-life experience of closely watching certain family members who retired too soon to a life of idleness . . . and does not come from any theologian.

This zeal for advocating work as good and healthy is not limited to work that is compensated with money. Any work that is purpose-driven is good for most people.  Delivering Meals-on-Wheels may be just as satisfying as being CEO of a big company.  Maybe, one is better for the soul while the other is better for the wallet, but both are purpose-driven, and I think both are good for people.

Most existentialists view the world through the prism of absurdity, grading things between very absurd or only slightly absurd.  That said, existentialists care little about debates over Predestination or Free Will or other theological issues.

Existentialism often lapses into Nihilism, which views all work as absurd -- because we're all going to die anyway.  But, existentialists are not that extreme.  They are still human and wish the best for others.

(By the way, an existential Calvinist would enjoy this ride through life, accepting all the "strum & angst" of life as both predestined and absurd.)

Monday, July 15, 2013

Boring But Important

The London Interbank Offered Rate or LIBOR was designed to measure the cost of borrowing between banks in London when they borrowed overnight to cover minimum liquidity requirements.  The rate would increase whenever the banking system had too little liquidity or too little cash-on-hand.  It was an early-warning-system for the Bank of England that it might need to increase liquidity by increasing the money supply.

About the same time, another strange currency developed, i.e., Eurodollars.  When the U.S. first became THE world currency, many businesses around the world needed dollars.  American sellers didn't want Greek drachma, for example, in payment for their exports to Greece.  They wanted dollars, which buyers had to buy before they could import goods from the U.S.  As they did more business with U.S. exporters, foreign businesses began accumulating dollars, which were held outside the U.S. and became known as Eurodollars.  However, the number of Eurodollars really increased during the Cold War, immediately following the Berlin airlift, when the Soviet Union was afraid the U.S. would confiscate their holdings of dollars in the U.S. and moved all those dollars, initially to Paris, as Eurodollars.

The next evolutionary step was that foreign businesses no longer had to buy dollars before doing business with U.S. companies.  Soon, they could borrow dollars.  But, what interest rate would they pay?  Over time, LIBOR rates became the primary interest rate measure for these Eurodollars.  Estimates on the amount of assets, including home mortgages and derivatives, whose value is partially determined by LIBOR vary from $350 TRILLION to $500 TRILLION.  I suppose it is natural that such enormous amounts might attract some ethically-challenged folks?

Remember, if LIBOR goes up, home buyers have to pay more on their home mortgages.  If those rates go down, the retirees who bought mortgage-backed securities receive a smaller amount of income.

LIBOR is announced by a consortium of banks who theoretically call each other daily and ask "hey, what were your funding costs last night?"  Keeping this rate low obviously had a positive impact on bank stocks.

The latest news is that London bankers considered themselves too ethically-challenged to continue maintaining LIBOR.  Last week, it was announced that the all-important rate would now be maintained by a U.S. firm instead.  I guess they think Americans are never ethically-challenged ?

Extra, Extra -- Read All About It

My latest quarterly column for Inside Business on the economy and the stock market can be found at: 

Monday, July 8, 2013

Ending Hurricane Season

There is an old expression on Wall Street that it is always "climbing a Wall of Worry."  We saw that last month when the stock market had a temper tantrum following Ben Bernanke's press conference.  Most such emotional outbursts are more annoying than instructive.

But, there is something bothering me that I don't think the market has focused on . . . yet.  And, that is the calendar.   In late September, the Fed is expected to announce some tapering in quantitative easing.  That is also the election in Germany where Merkel is expected to win but only after a national discussion on bailing out the rest of Europe.

In October, it is expected that Greece, Portugal, and Cyprus will need another bailout of about $256 billion, which is an astronomical sum.  More write-down of existing bonds is inevitable, but the IMF has already said they will not agree to this.

Also, in October, it is expected that the U.S. debt ceiling will come to a vote in Congress, and we know what a circus that can be.

Did I mention that the stock market hates uncertainty and usually goes down when uncertainty goes up.

Also, did I mention that October is historically the worst month of the year for stocks?

Does that mean we should sell all our stocks and go to cash now?  Absolutely not!  But, it does suggest a little extra cash on hand would ease the market volatility and provide the dry powder for bargain-hunting later.  As always, be vigilant about a derivatives blow-up in Europe and keep your finger near the SELL button.

Now, enjoy your summer!

Sunday, July 7, 2013

Brief Economic Data

Consumer confidence reached a six-year high in May before falling slightly in June.  This is good news, but we always looks for some confirmation of economic data.  One of Alan Greenspan's favorite economic indicators was the Men's Underwear Index (MUI).  Because so few people ever see men's underwear, replacing it is an expense that men readily defer when the economy is weak.  Sales of men's underwear drop like a rock when the economy stumbles and recover slowly when the economy rebounds.

So, it was good confirmatory economic news last week when the marketing research group NPD Group announced that sales of men's underwear has rebounded a whopping 7.9% over the past year!

My analysis of this economic news is that, at first blush (literally), a huge 7.9% jump in men's underwear sales suggests the economy is growing even faster than 7.9%, which would be a fantasy.  I suspect this surge reflects the long length of this weak economy recovery.  Men have delayed the purchase of new underwear for so long, that they were forced to finally replace their stock of drawers.

While men's underwear represents a tiny percentage of the gross domestic product (GDP), the logic of playing catch-up or replacing worn-out stock could have big implications.  As our slow economic recovery has lumbered along, the average age of cars in the U.S. has grown to 10.8 years, which is an all-time high.  Replacing that huge fleet will have a huge economic impact and cannot be postponed forever . . . like men's underwear.

I wonder how old is Mr. Greenspan's underwear anyway . . . no, never mind!

Saturday, July 6, 2013

So, Stop Studying The Stock Market Already!

The Department of Labor issued their latest Jobs Report yesterday.  Of the 130 economic reports issued each month, the stock market focuses most intently on this one.  While the stock market is famous for over-reacting, it is most famous for over-reacting to this report.

Yesterday, we learned that non-farm payrolls increased by 195 thousand in June, which was more than expected.  Private sector jobs increased by 202 thousand, also more than expected.  More significantly, we learned that another 70 thousand jobs were created in April and May than earlier reported.  All of this is good news!  We have been averaging about 175 thousand  new jobs for over a year and are now averaging 199 thousand.  (The economy is slowly improving, with no thanks to Congress.)

Before the report was issued at 8:30 AM, Dow futures were up 146 points.  Normally, futures are flat or zero before the report.  This time, the market was catching up on comments made by the head of the European Central Bank (ECB) that they would maintain low interest rates "for an extended period" which caused a big rally in Europe, while we were closed for Independence Day.

Following the report, the Dow lost all 146 points and actually went negative for awhile.  But, by the end of the day, the Dow closed up 147, almost exactly where Dow futures were before the report.  So, how do you interpret the market's reaction?

Either the market ignored the good Jobs Report or the market ignored the big rally in Europe or the market simply reflected the fact that most traders had already escaped Wall Street and were in the Hamptons for a long weekend.

You do know you'll go crazy if you try to figure out short-term movements in the market, don't you???

Thursday, July 4, 2013

Fatherly Advice

It may be the best advice my father ever gave me:  Never discuss politics or religion!  That was good advice, which has helped over the years.  Sometimes, my love of economics would cause me to slip into a political discussion, but I've faithfully avoided any discussion of religion.  It is simply too important and too private to discuss with mere mortals.  In fact, I would rather discuss my last visit to the urologist in front of a crowded convention center than discuss my last visit to church in front of a crowd of one.

Now, there is also a common courtesy among writers that we read each other's books . . . oh, what to do, what to do . . .

Jerry Maxwell is a good & decent man, whom I've known for many years and also happens to be a devout Christian.  He has written a short but serious book on the management of new churches, entitled Across the Aisle.  He makes a compelling case that churches should be built "bottom-up" from "life groups."  Too often, some denomination decides to start a church somewhere, and they impose more organizational structure than necessary for growth.

I enjoyed this book, this peek into a world I don't know.  Jerry also discusses what defines leadership in developing a new church, and it is remarkably similar to corporate leadership, if not military leadership.  A leader is humble enough to even wash the feet of his followers.  There is much to learn from reading this book, and I look forward to his next one.

But, I wonder if his father also told him never to discuss politics or religion . . . I salute him for being able to discuss such a forbidden subject intelligently.  I'd probably just wind up writing a book about my last visit to the urologist. . . .

Wednesday, July 3, 2013

Just Another Declaration ?

When, in the course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the laws of nature and of nature's God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.  That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed.  That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness. Prudence, indeed, will dictate that governments long established should not be changed for light and transient causes;  and according all experience hath shown that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed.  But when a long train of abuses and usurpations, pursuing invariably the same object evinces a design to reduce them under absolute despotism, it is their right, it is their duty, to throw off such government, and to provide new guards for their future security.--Such has been the patient sufferance of these colonies;  and such is now the necessity which constrains them to alter their former systems of government.

July 4th, 1776

Tuesday, July 2, 2013

So . . . What Happened to Gold ?

The second quarter of this year was the worst quarter gold has ever experienced, since markets began trading it many years ago.  From over $1,900 per ounce a few years ago to less than $1,200 at quarter-end, what happened?

The truth is seldom flip, and neither is this.  First of all, since we measure the value of gold in dollars, the value of gold falls when the value of the dollar rises, as it did this quarter when the world realized the economic engine of the world might not be China after all, but might instead still be the good, old U.S.A.  Plus, with everybody misunderstanding Bernanke's last press conference, the world expected higher interest rates in the U.S., which would drive up the value of our dollar, further driving down the value of gold.

Secondly, China is the world's second largest purchaser of gold, and their purchases decreased as their economy cooled, which is normal.  Third, the world''s largest purchaser of gold is India, where gold has almost a spiritual significance.  They also decreased their purchases as their economy has cooled.  This decrease in purchases was exacerbated by a decline in the value of their rupee currency, which drives up the value of gold when measured in rupees.  As the rupee lost value, they had to pay more rupees per ounce of gold, and therefore bought less.  Lastly, the Indian government imposed a luxury tax on gold purchases, making it even more expensive for Indians to buy.

The recent recovery in the price of gold to about $1,250 per ounce does not signify any serious rebound for the short-term.  One reason for this bounce in price is that some investors have been covering their short positions and are not really buying gold to hold, just to cancel a short position, which means they previously sold gold they did not own and might have to actually own some gold to surrender to their purchasers.  Another reason is that the Indian wedding season is already over, so there is a normal seasonal swoon to gold prices, and we missed the season.

Lastly, there is no believable, verifiable indication of inflation yet, which normally drives up the price of gold.  When we can actually see inflation on the horizon, gold will rise . . . as long as the Indians keep getting married, of course.