Saturday, January 31, 2015

Pity The Fool ?

One of my favorite quotes from the Rocky movies was the line by the champ (Mr. T) that "I pity the fool," referring to challenger Rocky Stallone.  Sometimes, economists are as arrogant as the champ.

This blog has discussed the problem of a strong dollar quite often.  Yesterday's announcement that GDP growth was only 2.6% in the fourth quarter of last year is proof of the problem.  Most economists were expecting about 3% or better.

However, with the dollar strong, Americans found foreign-made products cheaper and bought more from other nations, pushing our imports up.  Conversely, with the dollar strong, other nations found American-made products more expensive, forcing our exports down.  As a result, our trade deficit widened, which causes GDP growth to decrease.

How much did the trade deficit widen, you ask?  Enough to drop GDP growth in the fourth quarter from a healthy 3.8% to only 2.6%.  In other words, our growth decreased by 32% due to the strong dollar.

Politicians like to strut and take credit for the strong dollar.  Sometimes, economists just look at politicians, roll our eyes, shake our head and . . . "pity the fool."

Wednesday, January 28, 2015

When Is Fast Too Fast?

For about ten years, investment strategists have been arguing that, since half of the world's stock is outside the United States, we should invest about that much in foreign stocks.  In other words, about 50% of your portfolio should be invested internationally.  One way to do this was to buy the stock of large U.S. multinational companies, whose revenue from foreign nations already exceeds 50% of their total revenue.  When the dollar was decreasing in value, that made their foreign earnings even more valuable.

Now, that has changed.  The recent earnings announcements by Microsoft, Pfizer, Caterpillar, P&G and other large companies all attributed disappointing earnings to the appreciating dollar.  (Foreign earnings were no longer able to buy as many dollars now that the dollar is so expensive.)  The stock market dropped almost 300 points that day.  Just for good measure, it dropped another 200 points today.

Chart of the Day

It sure looks like we are entering a "currency war," where each nation wants to cheapen its currency to help its exports and labor force.  Because the U.S. economy is relatively strong compared to other currencies, we can take the economic loss from a stronger dollar without complaining too much.  After all, we want other economies to be stronger as well.

But, how much is too much?  The chart above shows a near vertical ascent of the dollar since last June.  So, when is fast too fast?  This chart shows you the answer.

Tuesday, January 27, 2015

Not This Year

Last Fall, the CNBC Fed survey of economists and fund managers showed their belief that the Fed would not begin raising interest rates until this June.  That didn't make sense to me, and I suggested it would not happen until much later in the year.  Today, the latest survey showed their expectation that the Fed would not begin raising interest rates until this September or three months later.

It still ain't gonna happen!

The Fed will not raise rates before December at the earliest, for two reasons.  First, Fed Head Janet Yellen is a dove, meaning she worries more about unemployment than inflation.  While the simple unemployment rate has fallen nicely and the economy did produce three million jobs last year, she is very sensitive to the high U-6 level of employment, which includes those part-timers who cannot find full-time work, plus the historically low 62.7% rate of the population that participates in the workforce and actually looks for work.  Keeping rates low will help.  Higher interest rates certainly will not help!

Second, the dollar is getting too strong, which is already hurting our exporters such as Caterpillar.  Raising interest rates in this country will make the dollar even more strong and hurt our exporters even more.  As Europe falters, that also makes the dollar stronger.  As China slows down, that also makes the dollar stronger.  All this ain't good!

Unfortunately, there is little the Fed can do right now, especially since they are the only branch of government that has done anything helpful so far . . .

Monday, January 26, 2015

Crybaby Nation

Imagine a Shangri-La where everybody gets free medical car and everybody retires at age 60 unless they have a hazardous job, like hairdressers who must work with dangerous chemicals, you know, or disc jockeys, who are around electrical equipment, you know.  They get to retire at age 55.

Imagine a national joke about paying taxes, where he who cheats the most is most respected.  Imagine having a job with a month's paid vacation, where you cannot be fired--absolute job security.  Imagine having the price of foodstuffs like milk subsidized by the government, so you can buy even more.  Wouldn't all this be wonderful?

Now, imagine somebody tells you the party is over.  GDP drops a staggering 27%, compared to 30% for the Great Depression in the U.S.  Unemployment rises to 28%, compared to "only" 25% during the Great Depression in the U.S.  It drags on for five miserably long years, compared to nine years of the Great Depression.  Even worse, government officials start demanding you actually pay taxes and don't get the joke anymore.  Now, other nations ridicule you and make fun of you.  They call you "spoiled children."

Why is everybody so mean to you?  You were happy and not bothering anybody.  What has changed to make the world so mean?  Maybe, we need a new government, yeah, a new government, so we don't have to change anything nor abide by the laws of economics anymore?

As expected, Greece elected a left-wing semi-socialist political party to protect their prerogatives and pampered way-of-life.  To do so, the new government promised to negotiate with their creditors to reverse the austerity measures that they had previously required.  In response, credit default swaps for Greece rose almost 11% immediately.  They are now the most expensive swaps anywhere in the developed world.  Very few expect those bonds to be repaid as promised.

Unlike three years ago, this did not come as a surprise.  Their debt was 160% of their GDP then, compared to 175% today.  (The U.S. is about 95% right now.)  Because no nation has ever left the European Union, it is not clear what will happen if Greece leaves (the Grexit), but I am not terribly worried about it!  It will be messy and make the stock markets choppy for awhile, but it will be good for the EU in the long run.  It will be good for everybody except the Greeks.

Greece took advantage of the strong currency of the EU to finance their borrowing at lower rates than their individual credit justified.  If they leave the euro, their borrowing costs will go up greatly.
I feel sorry for the Greeks.  (Of course, if they leave the euro, their exports should soar, because their new Greek currency will be almost worthless.)

For those bonds already issued, they are now in "strong hands" of the EU, the ECB and the IMF.  They have largely been removed from the private sector, except for a few courageous/stupid hedge funds.  I don't feel sorry for the hedge funds . . .

This is what happens when you put your grandchildren into debt to pay for your entitlements today.

Sunday, January 25, 2015

American Hero

Clint Eastwood's new movie American Sniper is a must-see for every lover of America.

It is not about war.
It is not about the Iraqi war.
It is not even about warriors.

It is about one particular warrior in the Iraqi war.
It is about one particular American Hero, who deeply loved his country.
It is a true story about a genuine "Boy Scout."

It is also about the "warrior code" and the camaraderie of those living with horror.
It is also about the invisible illness of Post-Traumatic Stress Disorder (PTSD).
It is also about wives who remain in safety but must live with a crushing fear of a ringing telephone.

Chris Kyle was indeed a SuperHero, with breathtaking marksmanship.
Once, I wore my expert marksman badge proudly but am not good enough to carry Kyle's backpack.
He made a head shot at 2100 meters, more than a mile away -- a head shot, no less.

With each succeeding war since World War II, an ever smaller percentage of the population serves to protect an larger percentage of the population.  While that is probably a good thing, it does make our relatively few warriors ever more important to the rest of us.  We need every Chris Kyle we can find.

It is cleansing to watch his movie.  It would be an honor to salute him!

Thursday, January 22, 2015

All Eyes On Europe

This morning, the European Central Bank announced it would begin quantitative easing (QE) in March by purchasing 60 billion euros or about $70 billion of "bonds" each month until Fall of next year, if not longer.  This was more than expected, and almost as much as the $85 billion the Fed was buying before it ended QE last Fall.  Dow futures immediately jumped upwards from about 45 point to 125 points, before dropping back as questions arose, such as what kind of bonds and how much of the 60 billion is "new money" in addition to its present bond-buying program.  As hoped, the euro depreciated and the dollar appreciated, which is good for European businesses and bad for American businesses.

The ECB is following the well-worn path of the Federal Reserve, the Bank of Japan, and the Bank of England, simply because Germany has been dragging their well-healed feet.  The common denominator is that each nation needs budget reform but, since their democratically elected governments are impotent, their central banks are forced to stimulate the economy in any way they can.

Right now, the risky 10-year Spanish government bonds are only paying 1.4% compared to risk-free U.S. Treasuries paying 1.9%.  That does not make sense.  And, that which doesn't make sense will not last.

In addition, don't forget the election in Greece this weekend.  It is expected that the socialist party will win and will put an end to austerity, which could preclude any additional assistance from the European Union, causing Greece to exit the EU.  There is a great deal of anxiety as to whether the EU can survive, but I am not one of the worriers.  It will be bumpy for a short while, but that is all.

Lastly, all of the world's most beautiful brains are now assembled in Davos, Switzerland -- setting a very high standard for "group-think" . . . at least, among the 1%.  Pay attention!

Wednesday, January 21, 2015

Middle-Class Economics ??

I didn't watch the State of the Union address last night.  It was past my bedtime, plus I already knew whatever the President said would be dead-on-arrival and could already cite the reasons the Republicans would use to explain why everything was dead-on-arrival.

But, apparently, the President coined a new phrase -- middle class economics.  I've been scouring the internet looking for a definition without success.  Given the source, the term must be rooted in Keynesian economics.  But, it reminds of of a famous urban myth that the CEO of GM once said "whatever is good for GM is good for the country."  I think "middle class economics" means that anything that is good for the middle class is good for the country.  This neatly justifies a higher tax on the upper class to pay for middle class entitlements.

And, by the way, the CEO of GM never made such a foolish statement.  In 1953, Charles "Engine Charlie" Wilson had that job until nominated by President Eisenhower for Secretary of Defense.  He was asked if he could act as Secretary of Defense in a way detrimental to GM and replied that such a conflict was highly improbable "because for years I thought what was good for the country was good for General Motors and vice versa."

Tuesday, January 20, 2015


A recent editorial in Investment News began with "Despite what one may read in newspaper headlines or see on nightly television news shows, the business of providing financial advice is an honorable one -- no less honorable than teaching children, taking care of the sick or keeping criminals off the street.  In fact, a person who becomes a financial adviser isn't making a career choice:  he or she is answering a calling."

While my inner-cynic screams in disagreement, I do confess to feeling that calling.  I help people and enjoy doing it!

The editorial goes on to request help for a particular financial adviser, who is suffering for Leukemia, by donating bone marrow.  I lost a good friend and client almost two years ago to that disease and wanted to help.  So, I went to the website to learn how easy it is.  However, if you are 60 years of age, YOU ARE TOO OLD to help?!?!

My first thought, entirely ego-based, was that I can still kick the butt of whomever established such a stupid restriction.  My second thought was that age discrimination is based on nineteenth century statistical information and medicine.  My third thought is that many of my young, childish, diaper-wearing readers are still under age 60 and could help save another human being by going to that website.

Hint, hint . . . what are you waiting for?

Monday, January 19, 2015

Timing Is Everything

I write a quarterly column for Inside Business which is supposed to take both a look back as well as a look forward.  The most recent column can be found here: 

Unfortunately, that column was submitted just before the Swiss National Bank unexpectedly allowed their currency to float.  That announcement may turn out to be the most significant economic event of this year.  It also raises the probability that we could see a derivatives failure.  In fact, several currency traders have already filed for bankruptcy, and nobody knows who has guaranteed a price for the Swiss currency.

Increased scrutiny of the derivatives market is required for the next few weeks.

Sunday, January 18, 2015

Melancholy About "Melancholia"

We just watched Melancholia, the highly-existential 2011 movie offering by Lars von Trier, who is  seriously-talented as a writer and director but might be sadly-flawed as a person.

The movie is a study of two sisters - one who is sensible and responsible and the other who is depressive and socially dysfunctional.  During the first half of the movie, the sensible sister tries to help her "weaker" sister get married and celebrate the occasion appropriately but failing miserably.  Then, the roles reverse when it becomes apparent that another planet, aptly named Melancholia, will soon collide with earth, killing everybody.  At that point, the depressive sister finds meaning and happiness, while helping her formerly sensible sister adjust to their rapidly approaching death.

While the collision of planets seems hardly plausible in any movie, it does lend a remorseless existential inevitability that becomes the fulcrum of the sisters' relationship.  It is characteristic of von Trier to develop the protagonists of his movies in a soup of surrealism.  Still, it is interesting to see different people react to the same fate.

A normal, well-adjusted person might react to the pending cataclysm by saying "Oh, no, I'm don't want to die" . . . as panic begins.

A person with clinical depression might say "of course, what else can happen to me?"

A nihilist might say "finally" with great relief.

An existentialist would say "Crushed by another planet hitting earth - that's absurd - almost as absurd as all these people running around in a panic - maybe we should just enjoy one last glass of good chardonnay?"

Saturday, January 17, 2015

Don't Stop Thinking About . . .

Presidents always get too much credit for good economic times and too much blame for bad economic times.  After all, the world's largest economy has its own momentum.  And, it changes direction and speed like an aircraft carrier - S - L - O - W - L - Y.

In 2007, we were running a huge budget deficit, about 10% of GDP.  That was significant as much research have shown 10% is often a "point of no return" beyond which a nation slides into the economic abyss, like Greece.  By 2014, that annual budget deficit was down to 3%. which is below the average deficit since the 1980s..  This was a huge improvement, primarily because the GDP has increased so much since 2008.  (While the deficit has decreased from a trillion dollars per year to "only" $488 billion now, it is expected to begin increasing again next year, as the financial burden of the "boomers" begins straining our government resources, forcing future generations into debt.)

This improvement was also helped by the process known as sequestration, which set arbitrary dollar limits on discretionary spending, seriously damaging our military preparedness.  Just as an alcoholic must hit bottom and admit his limitation before improvement can be made, Congress recognized and accepted its own uselessness and inability to compromise on a budget by imposing the arbitrary spending limits of sequestration.  (Unfortunately, entitlements like Social Security and Medicare are not subject to spending caps.)

So, let's just celebrate our success, even if the cause is a little disappointing.

Just as Fleetwood Mac sang about "don't stop thinking about tomorrow," don't stop visiting this website: 

Thursday, January 15, 2015


In the wee hours this morning, European stock markets went crazy.  Unexpectedly, the Swiss National Bank announced it was no longer supporting the cap on the Swiss franc, which immediately jumped almost 20% in value.  This was a huge unexpected jump to occur at one time.

Remember that Switzerland maintains its own currency and does not use the euro.  If the Swiss franc (called the Swissie) gets too strong against the euro, that will make the goods manufactured in Switzerland too expensive to be purchased by anybody using euros to buy the goods.  To keep this from happening, the Swiss National Bank (SNB) has been selling francs to buy euros, maintaining about 1.2 francs per euro.   The problem is that the euros were depreciating, causing losses on its balance sheet.

So, why stop supporting the Swissie now, after doing so for the last three years?  Because the quantitative easing in Europe is now almost certain to start next week and QE causes the currency to weaken.  (You'll recall how the dollar began strengthening when we started tapering our QE.)  The sooner the SNB stopped supporting the franc, the sooner the drain on their balance sheet would stop.

The long term impact of this is hard to predict quickly.  It will now be extremely expensive for Europeans to visit Switzerland or buy anything from Switzerland.  It will also make it more expensive to buy from the U.S., because it is now very likely that the dollar will appreciate even more, which will put even more downward pressure on commodities like oil.  I suspect this finishes any chance that the Fed will raise interest rates this year, as that will only make the dollar even stronger.  Once that washes through the market, that should increase the value of high-yield bonds and dividend-paying stocks.  Our exporters, mostly large-cap stocks, will be hurt by increasing dollar strength.

If there is a lesson here, it is that no central bank can intervene in the currency market for long, not even the Swiss National Bank.  If there is a reminder here, it is that central banks must telegraph their actions and not surprise the markets.  

Wednesday, January 14, 2015

Missing One Bullet But Not Another

Like a new father getting up for a 3:00 AM bottle feeding, I was up at 2:45 AM.  Instead of heading to the kitchen to warm the bottle, I headed to the kitchen for hot tea, before positioning myself in front of the television and wait for the legal opinion from the special counsel of the European Union Court of Justice on whether the European Central Bank (ECB) could proceed with its quantitative easing (QE) plans for next week.

Of course, self-important lawyers move at their own pace, and the announcement was not made until 3:40 AM.  (Grrrrrrr!)  But, it was good news!  With some conditions, the ECB may proceed with QE!  Dow futures had been indicating a 100 point loss at the open, which then improved to a flat open.  The euro immediately dropped to a six-year low against the dollar, as the market now expects the ECB to flood the world with euros by using QE..

The ECB has faced more obstacles than the U.S. Federal Reserve or Fed.  The primary obstacle is Germany, the home of Austrian economics.  Just as the Republican party wants to impose supply-side economics on the Office of Management & Budget to use at all times and in all economic environments, Germany seeks to impose Austrian economics at all times and in all economic conditions.  Germany lost this morning, and that's a good thing.


After a short nap, I was surprised to see Dow futures had moved past the more important uncertainty of QE in Europe and was now focused on the surprisingly poor retail sales in December and on JP Morgan's disappointing earnings.  More interestingly, the World Bank decreased their estimate of global growth for this year and next year.  Cooper, which is often called "Dr. Cooper" for its ability to predict economic growth, then plunged to a five year low.  All this caused Dow futures to drop 253 points.  So, have a nice day anyway!

Tuesday, January 13, 2015

Squid Slime ?

Here are the latest thoughts from the highly-self-respected Wall Street investment bank, Goldman Sachs:

1.  Global economic recovery will broaden this year - not just the US.
2.  GDP growth in the US will be above 3% this year and next year.
3.  No inflation on the horizon.
4.  "MLPs remain ideally positioned to the energy opportunity."
5.  Japan & Europe may have bottomed out.
6.  Strong demand for "junk" bonds will continue.
7.  The dollar will continue to strengthen, with the euro dropping to $1.15.
8.  Oil will rebound to $85 within 3 months!
9.  Gold will continue dropping to $1,050 by next year-year end.
10.  First rate-hike by Fed not until the second half of this year.
11.  No expected increase in wage growth, unfortunately.

While I'm just guessing, it seems to me that a new person must be writing their Market Pulse, as this one is so well-written.  I think the following quote is simply artful:

The geopolitical condition is often quite difficult to quantify and unpleasant to summarize.  Although turmoil in Russia and Ukraine and in the Middle East bears watching in 2015, the majority of geopolitical hotspots are, in our view, regionally tethered and of limited broader economic consequence.

Saturday, January 10, 2015

Extra, Extra . . . Read All About It

The IRS has just released their latest statistics on the year of 2012.  The top 1% paid 38.1% of all income taxes, up from 35.1% the previous year.  Their share of total personal income increased to 21.9% of all income.  Their adjusted gross income (AGI) started at $434,682.

The top 5% received 36.8% of all income and paid 58.9% of all income taxes.  Their AGI was at least $175,817.

The bottom 50% paid only 2.8% of income taxes but did pay the overwhelming share of Social Security taxes.

The Republican position is that it is not fair to make 1% pay 38% of income taxes, even if they pay a much smaller percentage of total taxes.  The Democratic position is that it is not fair that Social Security taxes stop at $118,500.  My position is that it is not fair to describe anything with the "dog-whistle" word of . . . fair.

Making The Sale

Years ago, a seminary student joked with me that the way to spell religion was p-a-r-a-n-o-i-a.  I suggested the correct spelling should be f-e-a-r, as in fear of going to Hell.  No, he explained, just like consumer goods are sold with sex appeal, some religions are sold with fear.  While they may "make the sale" by scaring people, it is paranoia that binds the followers together.

After all, every major religion feels persecuted.

Watching the tragedy in Paris reminded me of that conversation.  The huge disaffected population of Muslims in France certainly provides a fertile ground for radicalization.  The sins of France in abusing and then deserting Algeria during the late 1950s and early 1960s came home when huge numbers of French-Algerians escaped retribution in Algeria by fleeing to France.  Once there, they found the French unenthusiastic about the growing numbers of Muslims, reminding the French of their embarrassment and loss in Algeria.  Feeling unaccepted, the Muslims became paranoid and clung even more closely to their religion, eventually losing interest in being accepted.  Now, the French are faced with the question of how to assimilate those who no longer wish to be assimilated?

The easy "sale" is to the French, that they need to reach out to Muslims, befriend some and find jobs for the young, where 40% are unemployed.  The hard "sale" is to the Muslims, that their religion is indeed respected and that working is better than fighting and dying.

Paranoia has to be replaced by opportunity.

Wednesday, January 7, 2015

Je Suis Charlie

There are hundreds of millions of Christians in the world.  Certainly, in a number that large, there are some crackpots.  Remember the crackpot from Topeka, Kansas, who felt God wanted him to picket the funerals of our soldiers who died in war?  Such extremism is a cancer that can grow and destroy a great religion.  Fortunately, one of the great strengths of Christianity is that we do marginalize our extremists.

There are hundreds of millions of Muslims in the world.  Certainly, in a number that large, there are some crackpots.  Remember the Ayatollah who first put a death warrant out for a writer who wrote a densely-written book that nobody could read?  Such extremism is a cancer that can grow and destroy a great religion.  Unfortunately, one of the great weaknesses of Islam is that they cannot marginalize their extremists.

Now, imagine a world where I could not write those words . . .

The Sweet Smell of Black Gold

The heart-stopper du jour for the stock market has been the merciless, unexpected collapse in oil prices.  It was so severe and so sudden that the industry was totally unprepared.  But, maybe it has fallen more than is justified.  Take a look at this graph:

Chart of the Day
The dramatic drop in the price of oil matches that of the Global Financial Crisis, which we are NOT experiencing right now.  Either there is a fundamental restructuring that has been forced on the huge oil industry -- that nobody foresaw -- or oil is oversold and will rebound at least to the $65/bbl range.

I think it is time to buy some oil companies with exposure to the Eagle Ford and Permian Basin, which are lower-cost fields, especially those companies with enough cash to buy those competitors that are certain to fail shortly.

You Say Tomato And I Say . . .

There is much discussion currently about deflation, especially since Europe has now demonstrated some minimal lower year-over-year consumer prices.  This is not good!

Everybody knows inflation means rising prices.  It is something we have experienced in our own lifetimes.  Deflation actually sounds pretty good.  After all, who doesn't like a lower cost-of-living?

Here is the problem:  we know how to stop inflation, by raising interest rates.  In some cases, raising taxes will stop inflation.  Deflation is a different problem.  Because prices are dropping, people start deferring purchases because they can buy it cheaper later.  Sales and profits immediately drop, while layoffs increase.  Even worst, we don't have any proven techniques to stop deflation.

World War II is often given credit for ending deflation during the Great Depression, but that was during a time before the federal government already had huge budget deficits.  In other words, we had enough "dry powder" to lift the economy out of deflation.  That option is not available this time, for obvious reasons.

Deflation is like cancer and must be eliminated before it spreads.  The only man who can do this is Mario Draghi, head of the European Central Bank.  But, he is being pounded by the Germans.  Say a little prayer for him!

Monday, January 5, 2015

Not Your Parents Old 1-2

No, it is not a left jab to the face, followed by right roundhouse to the ear.

Instead, it is two pieces of bad information, both of which raise uncertainty, something which stock markets just hate.  First, over the weekend, Germany called the bluff of Greece by saying the European Union would be just fine if Greece exited, the so-called "Grexit."  Did Germany mean that?  Did that mean they really expect the Grexit?  Were they just offering us a pat on the head, because they really expect the EU to fall apart?  So much uncertainty . . .

Two, the bottom fell out of oil, dropping below $50.  Maybe, it is not just a simple case -- of Russia cheating on their sales allocation and instead selling all the oil they can -- of what is driving up the supply of oil.  What if . . . maybe, it is a case of dropping demand, because global economies are stalling.  Maybe, the world is actually getting weaker economically and nobody knows it yet?  So much uncertainty . . .

Amidst all this uncertainty, let us not forget this time last January when the stock market dropped right at the beginning, rallied through March, when it dipped again but then rallied until October when it dropped almost 10%, just before rallying into year-end with a 10.4% increase over year-end 2013.   That worked out just fine, didn't it?

R - E - L - A - X . . . .

Sunday, January 4, 2015

Pet Peeve #847

Full Disclosure:  I have been a loyal, enthusiastic fan of the Dallas Cowboys since 1977.  When they lose, I become sad and despondent for days.  They matter to me!  But, I don't understand why professional sports, including the Cowboys, use superlatives continually.  Superlatives also matter.

My dictionary defines "hero" as "a man of distinguished courage or ability, admired for his brave deeds and noble qualities."  It says nothing about any "heroic goal-line defense."  Heroes are not found on any football field, unless their name was Pat Tillman, who gave up an NFL contract to lose his life in Afghanistan.  He was a hero.  He was not just another rich athlete pretending to be a hero.

While I respect the commitment of professional athletes to maximize their physical potential, they are mere shills for the almighty advertising industry.  They are paid to bring eyeballs to advertisements to drink more beer, buy new cars or whatever.  They are not heroes.  They are just athletes.  They exist only to entertain us enough to watch commercials . . . including my beloved Cowboys.

My point is not to denigrate hardworking athletes, nor to illustrate the reach of the unregulated advertising industry, but to question our need to use superlatives.  Howard Cosell invariably referred to the not-overly-educated football players as "brilliant" simply for running a good play.    Maybe, "color commentary" means the language has to be colorful or superlative?

Just as printing too many dollars cheapens the currency, overuse of superlatives cheapens the meaning.  If everything is superlative, then nothing is.

Saturday, January 3, 2015

Quantifying Risk

So, the Dow was up 7.5% in 2014 -- is that good?

From a historical viewpoint, that is almost average.  What is unusual is that this is the sixth straight year of a bull market, which tells us more about the severity of the Great Recession than it does about the Dow.

From a technical viewpoint, analysts wonder if the Dow was still improving as the year ended (it wasn't).  We wonder if the market appreciation was widespread -- limited to a few stocks or the whole market -- it was widespread.

From an allocation viewpoint, the Dow index measures only 30 stocks of the mega-large companies.  Did mid-sized and small companies also participate in the bull market?  (While small-caps did not appreciate as much over the full year, they were appreciating faster at year-end.)

From a sector viewpoint, since the Dow is mostly multi-national companies and will suffer from the stronger dollar, what other sectors did well?  (Technology, especially biotech, which are not in the Dow.)

Of course, the first thing most investors wonder is whether their individual portfolio was up 7.5%, which is unrealistic unless the Dow was their benchmark.

The most important question is what was the risk-adjusted rate of growth?  Is 7.5% return good?  No, not if you took a lot of risk.  Yes, if you took little risk.  Unfortunately, measuring risk remains more art than science.  Investment theorists rely on the standard deviation of share prices over time, which has certain statistical benefits but is not readily understandable by most investors, who have to rely on their own "street sense."  For example, are you diversified among stocks, with no more than 5-10% in any one stock?  Are you diversified across many asset classes, such as large-cap, mid-cap, and small-cap stocks?  Do you have any international exposure?  (Even if you are just an income-investor, you can still have a fairly diversified portfolio.)

Intuitively, I am convinced that the primary risk that is statistically ignored by traditional risk-adjusted analysis is geopolitical risk.  Was 7.5% for the Dow good -- given the amount of geopolitical risk last year?  The good news is that much progress has been made in quantifying geopolitical risk over the last two years.  Risk-adjusted rates of return will soon escape the realm of theorists and be available to investors . . . finally!