Saturday, April 29, 2017

The Best Bad Option

This week, I sat quietly and listened to several discussions among intelligent people about the Gordian Knot that is North Korea.  Such discussions usually recite a laundry list of things we cannot do, because it would involve the loss of human life.  It seems to me that the loss of human life is inevitable in this geopolitical tar-baby.

Eventually, the "crazy, fat kid," as Senator John McCain referred to Kim Jong Un, will develop an intercontinental missile capable of delivering a nuclear weapon to the western United States. That is the worst option.  Precluding this reminds me of President Truman's argument that the massive loss of life in Hiroshima and in Nagasaki was justified, because it prevented the deaths of uncountable Americans landing on the shores of Japan.

The "Soviet" option seems to be the most popular right now, which assumes we can bankrupt North Korea in an arms race they cannot win, like we did to the former Soviet Union.  First, I cannot see their egocentric leader leaving gracefully under any scenario -- without a blaze of glory. Why should he?  Second, the Chinese will be stuck with many of the 25 million North Koreans streaming across the border in search of food.  How many North Koreans will die in a regime collapse?

Rather than simply checking off a laundry list of options, we need an analytic discussion of how many people will lose their lives with each option.  How can any option be chosen without that information?  Of course, estimating the unknowable is always difficult, but that doesn't mean we shouldn't try.  Operating under "conditions of uncertainty" is not new.

There is an unfortunate racial dimension to any such discussion.  Is it better to let 1,000,000 North Koreans and another 3,000,000 South Koreans get killed now, in order to prevent the death of a million Americans in five years?  Well, is it?  What would Truman do?

One consideration is that South Korea was irresponsible in allowing enormous population growth in Seoul, which is only 35 miles from the DMZ and is within easy range of an estimated ten thousand long-range cannons.  They had a large country to the south of Seoul, outside cannon range, that could have been developed far more safely, to minimize the inevitable loss of life from the fanatical North Koreans.  They should be "hardening" their people right now, with fortified bunkers and such.  They can afford it.  After all, their economy is growing much faster than our economy (3.6% vs 2% in the US).

Like President Truman before him, President Trump must "play God," and I pray he makes the right decision.

Friday, April 28, 2017

Wages Up, Healthcare Costs Down?

As the economy has fairly-steadily improved since the global financial crisis in 2009 and as the stock market has risen nicely since then, worker-pay has remained stubbornly unchanged.  However, the latest data is much more optimistic.

The Employment Cost Index has just posted its best quarterly performance since 2007!  Undoubtedly, this reflects the tight labor market . . . finally . . . and probably explains the recent rise in Consumer Confidence.  Maybe, the weak retail sector will see some improving sales.  They need it!

One small but interesting data-point is that wages in the private sector rose 0.9% in the first quarter, compared to 0.6% in government.  It is unusual for the private sector to grow 50% faster than the public sector.  We can expect public unions to become more strident soon.

Another small but interesting data-point is that salaries are rising faster than benefits.  At first, it was assumed that employers realized that benefits can become unbearable during a recession and are fighting hard to control legacy costs.  Closer examination shows that healthcare costs are rising much more slowly than the overall rise in benefit costs.  In other words, non-healthcare benefit costs are rising faster than healthcare costs.  Does this tell us anything about Obamacare?  

Sunday, April 23, 2017

Changing Dance Partners

In this country, we tend to see people as members of the Republican Religion or the Democratic Religion.  In other countries, we tend to see people merely as members of the conservatives or the liberals/progressives.  That has been a convenient way to pigeon-hole or label individuals for a long time.

But, maybe that is changing?  The Brexit election in England last year was the first where voters were either nationalists or globalists.  To a large extent, our own presidential election last year divided us the same way.  The French election today will shed more light on this. ( La Pen represents the nationalists and is a direct threat to the future of the euro and possibly the eurozone.)

It is not news that "politics makes for strange bedfellows," but I find myself agreeing with a strange new group and disagreeing with an equally strange group.  To be permanent, political parties must support the realignment, and I have trouble imagining the Republican faithful giving up on regulatory relief and Democrats giving up on fairness.  Of course, it is not a simple matter of giving up on existing goals but is instead a matter of re-prioritizing goals.

I'm not sure who I am currently dancing with . . . ?

Are you a nationalist or a globalist?

Friday, April 21, 2017

Faith Restored

In the 1963 movie of Bye Bye Birdie, there was this wonderful song that begged the question of "what's the matter with kids today?"  It quickly became a standard refrain asked by grown-ups who are confused by non-grown-ups.  I have heard that particular question asked all my life.

I know, kids watch too much television and are more interested in their cell phones than their dinner.  They have little interest in learning the old, boring standard "stuff."  They are disrespectful and don't realize how lucky they are, because they are so entitled.  Everybody is a winner and has a trophy to prove it.  Punishment is too great a threat to self-esteem.

Yes, I fret about this country that I love.  There are so many problems.  I don't know how to solve all those problems and don't know anybody who does, certainly not a "slacker" in his parents basement.

But, sometimes I get a peek into the future.  Today, I was fortunate enough to attend a benefactors luncheon at the Virginia Military Institute in Lexington, Virginia.  I sat next to a cadet.  He was a tall, strapping quarterback in high school and a tight end now.  He was respectful.  His sentences were punctuated with "sir" and "ma'am."  He is a serious student and aware of how Lady Luck has smiled on him.  He knows that intelligence deserves education, which in turn requires that leadership be provided to others.

Just when I was ready to nominate this cadet for King, I looked around and realized there were hundreds of other respectable and respectful students (both male and female) just like him.  My faith in the future is restored!

Yes, there are so many problems, and I don't know how to solve all those problems, but I do know America is manufacturing new leaders today as they have always done.  America will be just fine!

Thursday, April 20, 2017

Does Time Matter?

It is difficult to complain about something you love and adore, but capitalism has failed us in the pharmaceuticals market.  Republicans reflexively allege this failure is due to too much government influence, while Democrats focus on who should pay for this failure.

I am one of the lucky ones.  The Veterans Administration provides my medications at a nominal cost.  They are permitted, unlike Medicare, to negotiate bulk prices from the large pharmaceutical companies.  Of course, I don't have access to the fancy, new, expensive drugs you see on television constantly, but seem to be just fine anyway.  Importantly, it is simple!  They check me every six months and then renew my meds, which arrive in the mail.  It is simple!

My wife is not one of the lucky ones.  She has suffered from frequent migraines for many years and unfortunately has to rely on private insurance.  From one month to another, she never knows which migraine meds will be approved for discounted prices.  Nine pills can swing from $30 one month to $370 the next month -- without explanation.  I assume such price swings reflect variable volume pricing from drug companies, which may be very capitalistic but is also very disorienting and confusing.  In addition, drugs approved last month may not be approved this month -- again, without explanation.

The Internal Revenue Service is required to list on each form the amount of time it takes an average person to complete that form.  Drug companies should be required to list how much time it takes the average person to understand their drug choices and drug prices.  Insurance companies should be required to list how much time it takes an average person to compare and contrast their different plan choices every year.  Should capitalism require a warning label that vast quantities of analytical time are necessary?  How much analytical time is possible or reasonable?

I have three degrees from three different colleges, but I am not qualified to distinguish between numerous, ever-changing drugs or insurance plans.  How does the average person?  The obvious answer is that they don't, but why do we expect otherwise?  Because capitalism requires that we believe analytical time is infinite?

You don't hear this very often . . . but, HOORAY for the VA!

Wednesday, April 19, 2017

Chicken or Egg?

Along the lines of which of "the chicken or the egg," does partisan identity precede or follow economic identity?  Are all Keynesian economists Democrats?  Are all Democrats also Keynesians?  Are all Austrian-school economists establishment Republicans?  Are all establishment Republicans Austrian.  Are all Supply-side economists closet Tea Party members?

Of course, the key word is "all."  There are exceptions to each of those broadly-true generalizations but not nearly enough.

Mark Zandi is one of my favorite Keynesian economists.  Backing Clinton last summer, he predicted a long, severe recession if Trump was elected.  Yesterday, he said . . . "never mind."

Now, he feels the economy will continue to roll along with a modest 2% GDP growth rate, despite the weak start in Q1.  He thinks job creation will continue at about 200 thousand monthly.  He sees no sign of recession in the foreseeable future.  Is this solid Democrat agreeing with Republicans?  Who knows, maybe he will evolve into the Austrian-school of economics??

I agree with his comments that the economy is not as good as the pro-Trump crowd expects, nor as bad as the anti-Trump crowd expects.  Hyperbole belongs in political discussions, not economic ones.

Tuesday, April 18, 2017

Briar Patch

There are thorny problems, and then there is the problem of North Korea, which has enough thorns to be an entire briar patch.

The basics are that a young, irrational leader of an small nation who has been tutored to think he can be important to the world only by threatening the U.S. with nuclear weapons, that his country cannot afford.  In reality, he is a military threat only to his neighbors, primarily South Korea and, to a lesser extent, Japan.

The Trump Administration has announced the end of the failed "strategic patience" with North Korea, and I applaud that decision.  But, there is still a need for "tactical patience" -- enough patience to harden the defenses of South Korea but no more.

Kim Jung Un is too unschooled, too insulated, and too irrational to survive.  He will unwittingly let his country be destroyed to prove his brilliance.  He will also show no mercy toward South Korea and will kill as many South Koreans as possible.  We cannot save North Korea, but we can save South Korea.

And, we should!

The aftermath will be messy.  South Korea might want control of or reunification with North Korea as compensation for their losses.  China does not want a common border with a U.S. ally.  I expect another buffer nation like North Korea will be established at considerable cost, which China and South Korea can afford.  At least, the next leader of North Korea is likely to be rational and stop threatening the U.S..

Monday, April 17, 2017

A Fulfiled Prophecy

In 1949, Robert Merton wrote a book entitled Social Theory and Social Structure.  In it, he coined the expression of "self-fulling prophecy", which is a prophecy, even a false one, that is made true by the actions of people.

For example, the value of a stock reflects supply and demand for that stock.  If Warren Buffett predicted that a certain stock was going up, other people would increase their demand and hurriedly buy that stock, which would drive up the price of that stock.  His prophecy would come true because of what people did.

A friend and client owns stock in a small public company and was wondering what impact it would have on the stock price if they became part of the Russell 2000 index.  I assured him that it would only help his  stock and not hurt it.  The reason is that all indexers or ETF managers or passive investors would be required to own his stock.  Right now, nobody is required to own that stock.  Thus, being included in the index increases the demand for that stock, which increases the price of that stock.

There have always been good investment managers, bad investment managers, and some really bad ones.  Indeed, there have always been times when an investor was better off just throwing a dart on the stock page (called the Random Walk theory) than paying an investment manager to pick stocks.  Eventually, some investment managers realized it would be a great marketing theory to argue that passive ownership of stocks arbitrarily listed in an index was superior to the active management of a portfolio.  The fear of picking a bad investment manager was therefore eliminated.  It was a great marketing scheme, and the argument has been raging for decades since then.  But, no more?

Recently, Standard & Poor's published their analysis of the last fifteen years, which demonstrated the superiority of not picking stocks over actually picking stocks.  The conclusion is pretty obvious, but I wonder if it was always that way, or it has become that way, due to the marketing success of such giants as Vanguard.  Think about it -- as more people were buying index products like SPY, which owns only the 500 stocks listed in the S&P 500, there were relatively fewer people to buy the thousands of other stocks that were NOT listed in the S&P.  (Some smart lawyer could argue that was discrimination against stocks outside the blessed 500.)

Much has been written in the academic literature recently about "over-fitting" or "p-hacking" which are statistical techniques used to bend data to support a predetermined conclusion.  While it does have some statistical rigor, it is intellectually ambiguous, to be kind.  Mark Twain was ahead of his times when he complained about "lies, damn lies, and statistics."

My disappointment with the latest analysis is that it is all statistics and doesn't explain why logic has no place in the discussion.  For example, since passive investors (index investors) have to remain fully-invested and cannot increase their cash level, how can passive investing possibly out-perform active investing during a bear market?  Yet another question is that, while investment data for the largest companies is widely known and offers no information advantage to investors, that is certainly not true for small companies, where information is very unevenly distributed.  Passive investing should not work nearly as well for small companies as large companies.  Is there no room for logic in statistics?

Although the Tipping Point is apparently behind us, where the notion that passive investing is better than active investing is made true by the actions of people, important questions remain.  One is whether investors are better off if they own indexes and don't know the companies they own . . . and don't own?  Is American business better off when there is a semi-permanent class of stocks that get an unfair advantage, just by being in the index?

Of course, the Standard & Poor's published analysis must be correct.  After all, I did read it on the internet.

Saturday, April 15, 2017

First Quarter Column

My quarterly column for Inside Business can be found here: 

Wednesday, April 12, 2017

Today's #1 Worry ?

Stocks are drifting downward.  Gold is drifting upward.  Bond yields are trending lower, as investors seeks to reduce risk.  Why?  Is it just a general sense of unease?  Is it fear of another Syria-type military action?  Is it President Trump?

If you look at the price of credit insurance on debt of Korea, you will see it is spiking much higher.  All those hedge funds and pension funds that own bonds issued by Korea are suddenly very worried they will not be repaid, so they are bidding up the price of credit-default-swaps.  It is clear that investors worldwide are concerned about many things, but they are REALLY worried about South Korea being "nuked" by North Korea.  It is the #1 worry.

As usual, John McCain was right when he predicted the world's greatest geopolitical risk is the leader of North Korea, whom he understandably called a "crazy fat-kid".

Investors worldwide agree!

Monday, April 10, 2017

Gerrymandering 101

I have written many times that gerrymandering is a cancer on our body politic.  Originally developed by Democrats, Republicans have now become addicted to it.  It is good for nobody, least of all the voters.

An excellent tongue-in-check explanation of it can be found here: 

If you are offended by profanity and off-color humor, you should NOT watch it.

Reducing the Fed's Balance Sheet

While Wall Street is focused on geopolitical affairs, the Fed is debating something else that deserves more attention -- whether or not to decrease the Fed's balance sheet.  The Libertarian wing of the Republican Party has been highly critical of the Fed for this and insistent that the Fed "deleverage" or sell bonds off its balance sheet.

During the long, slow recovery from the Global Financial Crisis, the Fed experimented with quantitative easing or QE, which has the effect of increasing money supply.  Within reason, an increasing money supply is good for the economy.  Reducing the Fed's balance sheet is QE-in-reverse.

The mechanics are this:  The Fed buys existing bonds, which are added to the Fed's balance sheet as an asset -- to pay for the bonds, the Fed issues new money -- the new money increases the total supply of money in the economy.  The reverse is this:  The Fed sells bonds on its balance sheet and receives cash from the buyer, which removes that cash from the money supply, because it goes back into the Fed.

Ben Bernanke says the Libertarians are wrong, and that we should not reduce the Fed's balance sheet at this time, and I agree.

The Fed has already begun the "normalization" of interest rates or increasing those rates to more a normal level, which has a chilling effect on the economy.  Increasing rates slow enough not to slow down the economy is an art, not a science.  These waters are murky enough, without implementing any QE-in-reverse program that has never been done before.

Wednesday, April 5, 2017

Impeachment Lessons?

The conventional wisdom about the impact of impeachment on the stock market is that it will be temporary.  After all, the stock market rose 226% during the presidency of Bill Clinton.  My experience tells me the market will sink . . . until it is clear that the President will not be removed from office, as it is impossible to get a two-thirds majority.

Fortunately or unfortunately, history offers us little guidance.  The impeachment of Andrew Johnson occurred before a "real" stock market existed.  The Dow Jones Industrial Average did not even exist.  Also, it happened very quickly, which is very different from today.  The market, such as it was, actually rose 10% in the three months prior to impeachment but fell slightly during impeachment, before rising another 6% in the two months after the impeachment trial.

The impeachment of Richard Nixon accompanied a much more volatile stock market.  It started with a 10% loss in the first month of 1973, increasing to an 18% loss by August, when a two-month rally raised stock prices 15% -- only 6% below its record high.  Then, the market did nothing until Nixon's resignation in August of 1974, when the bottom fell out.  Stocks lost 27% in just two months.  However, in November, the market shot up 16%, before turning around the next month and hitting the bottom, down 45% from the peak.  Five months later, stocks were up an astounding 48%!  Whew!!

The Johnson impeachment tells us nothing.  The Nixon impeachment tells us that "nervous" investors should sit on a large cash position.  The Clinton impeachment tells us NOT to be nervous and just wait for it to pass.

Before "nervous" investors begin selling stocks, they would be wise to establish a trigger that will tell them when to start buying their way back into the market.

Tuesday, April 4, 2017

The Joy of Landing

I actually enjoy flying on airplanes but hate being in airports, where passengers are stripped of their individuality, forced to draw-between-the-lines, and to follow precise instructions exactly -- or else.  Unfortunately there is now another innovation to make air travel even more miserable.

John McCain once said the worst part of being in a POW camp was being forced to listen to propaganda, which is just a fancy word for a mandatory sales pitch.

At home, you can turn off your television, change channels, or mute the sound, but not aboard an airplane.  For years, advertisers have been seeing all those eyes and ears just sitting on a plane and are willing to pay money to the airlines to put advertisements in front of those passengers.  Unfortunately, airline greed has now permitted the process to begin.  The passengers have been sold-out.  No more reading a good book or catching a few winks.

Today, American Airlines spends five --count'em, five - minutes regaling their passengers with the joy of some credit card.  Tomorrow, it will be soap powder.  Advertisers will pay princely to strut their commercials in front of all those innocent passengers.  And, the passengers cannot turn them off, change channels, or mute the sound.

Certainly, I would rather be a hostage on an airplane than a POW camp.  In both, you are no longer a human being.  You are merely a consumer of propaganda/mandatory sales pitches!