20 Observations On This Market

When the market gets wonky, I write more about current events. I prefer to write about longer-dated topics, because the posts will have validity for a longer time, and I think there is more money to be made off of the longer trends.

1. August wasn’t all that bad of a month… so why were investors squealing? The volatility, I guess… since people hurt three times as much from losses as they feel good from gains, I suppose market-neutral high volatility will always leave people with perceived pain.
2. Need a reason for optimism? Look at the insiders. They see more value at current levels.
3. Need another good investor to follow? Consider Jean-Marie Eveillard. I’ve only met him once, and I can tell you that if you get the chance to hear him speak, jump at it. He is practically wise at a high level. It is a pity that Bill Miller wasn’t there that day; he could have learned a few things. Value investing involves a margin of safety; ignoring that is a recipe for underperformance.
4. Call me a skeptic on 10-year P/E ratios. I think it’s more effective to look at a weighted average of past earnings, giving more weight to current earnings, and declining weights as one goes further into the past. It only makes sense; older data deserves lower weights, because business is constantly changing, and older data is less informative about future profitability, usually.
5. I found these two posts on the VIX uncompelling. Simple comparisons of the VIX versus the market often lead to cloudy conclusions. I prefer what I wrote on the topic last month. When the S&P 500 is below the trendline, and the VIX is relatively high, it is usually a good time to buy stocks.
6. What does a pension manager want? He wants returns that allow him to beat the actuarial funding target over the lifetime of the pension liabilities. If long-term high quality bonds allowed him to do that, then he would buy them. Unfortunately, the yield is too low, so the concept of absolute return strategies becomes attractive. Well, after the upset of the past six weeks, that ardor is diminished. As I have said before, to the extent that hedge funds seek stable, above average returns, they engage in yield-seeking behavior which prospers as credit spreads and implied volatilities fall, and fail when they rise. Eventually pension managers will realize that hedge fund returns cannot provide returns over the full length of the pension liability, in the same way that you can’t invest more than a certain amount of the pension assets in junk bonds.
7. Is productivity growth slowing? Probably. What may deserve more notice, is that we have larger cohorts entering the workforce for maybe the next ten years, and larger cohorts exiting as well, which will decrease overall productivity. Younger workers are less productive, middle-aged most productive, and older-aged in-between. With the Baby Boomers graying, productivity should fall in aggregate.
8. This is just a good post on sector data from VIX and More. It’s worth looking at the websites listed.
9. Economic weakness in the US doesn’t make oil prices fall? Perhaps it is because the US is important to the global economy, but not as important as it used to be. It’s not hard to see why: China and India are growing. Trade is growing outside of the US at a rapid pace. The US consumer is no longer the global consumer of last resort. Now we get to find out where the real resource shortages are, if the whole world is capitalist in one form or another.
10. Calendar anomalies might be due to greater macroeconomic news flow? Neat idea, and it seems to fit with when we get the most negative data.
11. Is investing a form of gambling? I get asked that question a lot, and my answer is in aggregate no, because the economy is a positive-sum game, but some investors do gamble as they invest, while others treat it like a business. Much depends on the attitude of the investor in question, including the time horizon and return goals that they have.
12. Massachusetts vs. the laws of economics. Beyond the difficulty of what to do with expensive cohorts in a public insurance system, I’ve heard that they are having difficulties that will make the system untenable in the long run… most of which boil down to antiselection, and inability to fight the force of aging Baby Boomers.
13. Rationality is one of those shibboleths that economists can’t abandon, or their mathematical models can’t be calculated. Bubbles are irrational, therefore they can’t happen. Welcome to the real world, gentlemen. People are limitedly rational, and often base their view of what is a good idea, off of what their neighbor thinks is a good idea, because it is a lot of work to think independently. Because it is a lot of work, people conserve on hard thinking, since it is a negative good. They maximize utility where utility includes not thinking too hard. Any surprise why we end up with bubbles? Groupthink is a lot easier than thinking for yourself, particularly when the crowd seems to be right.
14. Is China like the US with 120 years of delay? No, China has access to better technology. No, China does not have the same sense of liberty and degree of tolerance of difference. Its culture is far more uniform from an ethnic point of view. It also does not have the same degree of unused resources as the US did in the 1880s. Their government is in principal totalitarian, and allows little true freedom of religious expression, which is critical to a healthy economy, because people work for more than money/goods, but to express themselves and their ideals.
15. As I have stated before, prices are rising in China, and that is a big threat to global stability. China can’t continue to keep selling goods without receive goods back that their workers can buy.
16. The US needs more skilled immigrants. Firms will keep looking for clever ways to get them into the US, if the functions can’t be outsourced abroad.
17. It’s my view that dictators like Chavez possess less power than commonly imagined. They spend excess resources on their pet projects, while denying aid to the people whom they claim to rule for their benefit. With inflation running hard, hard currencies like the dollar in high demand, and the corruption of his cronies, I can’t imagine that Chavez will be around ten years from now.
18. Makes me want to buy Plum Creek, Potlach, or Rayonier. The pine beetle is eating its fill of Canadian pines, and then some, with difficult intermediate-term implications. More wood will come onto the market in the short run, depressing prices, but in the intermediate term, less wood will come to market. Watch the prices, and buy when the price of lumber is cheap, and prices of timber REITs depressed.
19. Pax Romana. Pax Americana. One went decadent and broke, the other is well on its way. I love my country, but our policies are not good for us, or the world as a whole. We intrude in areas of the world that are not our own, and neglect the proper fiscal and moral management of our own country.
20. Finally, it makes sense for economic commentators to make bold predictions, because there’s no such thing as bad publicity. Sad, but true, particularly when the audience has a short attention span. So where does that leave me? Puzzled, because I enjoy writing, but hate leading people the wrong way. I want to stay “low hype” even if it means fewer people read me. At least those who read me will be better informed, even if it means that the correct view of the world is ambiguous.

Comments

[jjason]

David, You have covered too many points in one article. Also, why use the term cohorts? I had to look the word up in my dictionary. Sorry,but cohorts doesn't add clarity to the problem of how to fund pensions. I am confused as to why no one understands that people who are retired do not want to risk their money in stocks and bonds? And when risk-free CD rates were two percent it forced retirees into the stock market. Investing in the stock market IS a zero sum zero game. As more people reach retirement age, they will discover that there are not very many companies that are concerned about the welfare of their shareholders. Most corporations pay dividends less than 3% and in meeting today's living expenses one would need $500,000 at 3% to generate $15,000 in income. Can you live on $15,000 a year? If you followed the AARP statistics over the past 15 years you will know that there are millions of Americans who may never be able to retire. The problem of pensions not being able to fund a decent standard of living for many Americans is a big one. I have no idea who is going to work on solving this problem. Wall Street has not solved the problem and neither has our government.

[Brian Croner]

I'll add point number:

21. The heirs to the US Dollar are losing options to dictatorship. The US, as a group striving for survival, are all bound together by the US Dollar. Those controlling the currency are downright backwards at survival. They could never survive on their own. They control the market more than anything else. Fundamentally, fundamentalists are inequipped to control a group striving for survival. They are taking everybody down with them.

[Brian Croner]

*unequipped

[Lee Carlson]

How about "illequipped"... ?

[semuren]

David:

Another very stimulating post. Thank you for all the effort you put into these.

“Rationality is one of those shibboleths that economists can’t abandon.” As an anthropologist I truly enjoy seeing sentiments like this in print outside of the academic world. While the simplifying assumptions of the dismal science enable its formalism they also often lead to neglect of difference that is truly consequential for what individual or groups seek to maximize and even the scope in which strategies of rational maximization are applied.

Along those lines I also feel compelled to comment on the following: “Is China like the US with 120 years of delay? No, China has access to better technology. No, China does not have the same sense of liberty and degree of tolerance of difference. Its culture is far more uniform from an ethnic point of view.”

While there is some academic debate in political science about whether China today is entering phase comparable to the Progressive Era in the US and developing a regulatory state (this is summarized in a dissertation that will come out of Cornell’s Government Department in the next few months), my real issue is with the contention that China’s culture is more uniform than that of the US in the post-Civil War era. Uniformity of culture in China is certainly the popular view, and the one expressed in works by researchers whose first hand knowledge of the place is limited to Beijing, Shanghai and Guangzhou hotels. It is also the view supported in China’s official media and scholarly discourse. According to these views China has 56 ethnic groups, and the largest one, the Han Chinese, comprise more then 90% of the population. The truth of the matter is that on the ground in city neighborhood and rural villages diversity is the most common place, especially among the Han majority. In fact if the standards used during the 1950s ethnic classification program had been rigorously applied to what are now grouped as Han there is no telling how many ethnic groups might have been “discovered.”

That said, Han ethnicity and the other ethnicities in China are profitably though of as political categories. The state project of homogenization and alignment of all notions of ethnic identity with the state itself is proceeding rapidly so that soon the Han category may reflect more real than simply ideological cultural uniformity.