Wealth, And Stories Of Wealth, Part 1: Finance At The Crossroads

by: Kurt Dew


There is some agreement among analysts that much of what has driven markets this month is unimportant “noise.”.

Maybe. But which sounds are noise and which are the melody?

This installment splits the Chinese noise from the Chinese melody.

What is creating all this beginning-of-year market chaos? Many events, or stories, that can be interpreted three possible ways:

  1. The event doesn't matter.
  2. It's not even happening.
  3. It might be good for the market and it might be bad.

An interesting article in the NY Times by Robert Shiller, here, discusses the general importance to markets of current events. Shiller calls them the current stories. Shiller's article, like any really interesting article, is itself a story. The story about the article is more important to investors than Shiller's story in the article. The bigger story has investment implications for the long term. I will discuss these long term implications here and in a couple later articles.

The article includes a terrific illustration by Koren Shadmi.

The Market's Stories, January, 2016.

Great picture, simultaneously depicting the current stories, and emphasizing that their significance lies in their interest and excitement in the telling, rather than their basis in solid evidence of real effects on long term U.S. stock market value.

The Shiller article tells these stories - the "surface" story - and introduces a theory that relates them to events important to long run investors. The surface story is Shiller's recounting of the facts underlying a conclusion that the events depicted in the picture above are not likely to lead to a recession in the U.S. He provides four market stories:

  1. The China story;
  2. The freak first week of the year story;
  3. The collapsing crude oil prices story; and
  4. The final correction to an irrational three years of market strength story.

He argues that the long run importance of these stories is, most likely, nil.

But Shiller's hidden, bigger, story takes the form of his reference to a recent book, by historian Ramsay MacMullen, "Feelings in History: Ancient and Modern." MacMullen's thesis (translated from his historical world into our financial world) is that there is a link between the many regularly occurring small stories in markets that affect prices today, but do not have persistence in determining long run value, and those larger events that do impact long run market value.

MacMullen's example of the relationship between small stories and persistent stories has some economic coinage, but that is, of course, not MacMullen's objective. MacMullen's example of his theory connects a mob killing in 1937 to the Civil War. The principle is that one event, the mob murder, in its retelling; leads to another event, John Brown's hanging; and another, until we are looking at a string of small stories that are a big event - in this case the civil war.

I respectfully disagree with both of these gentlemen. I am on board with Shiller's argument that little of great significance or long run market importance can be realistically inferred from his four current economic stories. But I do not see them as economic noise, to be disregarded, as Shiller suggests.

Each of these stories is being told, not because they are in themselves significant creators of long run market value, but because they are useful reminders to investors of something that is a significant creator of long run value.

In following articles, I will link each of these stories to their underlying market significance.

I begin with China's recent misadventures. Shiller is unquestionably backed by the facts when he suggests that China's tumbling market is a yawn. Behold the China market volatility chart from the St. Louis Fed's economic database, FRED.

So what is the big story that this Chinese market collapse story reminds us of? The big story is a long game of truth or dare. When will China "liberalize" its economy? Never.

China is one aspect of the financial crossroads at which our markets find themselves. Do you like misleading small stories like those provided by Shiller? China has a boatload.

  1. China is assuming its rightful place as a major economic power as the International Monetary Fund assigns it a share of its SDR basket of major currencies. Now it will tie its currency's value to that, not the dollar.
  2. China will pull out all stops to support its stock markets, including a currency devaluation.
  3. The Renminbi Yuan is no longer tied to other currencies. The currency floats.

The long story is that the current administration of China is a type. It is the heir to millennia of top-down planning and control in China. As an investor in China, you are not in the business of evaluating management; current results matter only through the good graces and good judgement embodied in the government's plan. Whatever might appear in the press releases of the officials of BRIC, I find only India to be credibly something other than a planned economy.

That said, comparing the quality of the plans of Brazil, Russia, and China is a little silly. Brazil and Russia may plan - but the quality of these plans are not comparable to those of China. Ironic, since the plan in China is doubtlessly the most difficult to execute.

But the underlying problem with all planned economies is the Fundamental Law of Big Plans: All big plans fail. The strength of capitalism is this: Capitalism, like evolution, has no plan. There is only survival.

For that simple reason, I believe investments that in China or any planned economy - which is all economies save a very few - must include one fundamental component. Why, when and how are you going to pull out? U.S. companies and individuals, like military actions, should always include an exit strategy. That is missing in the recently announce pullbacks from Asia by BNP Paribas (OTCQX:BNPQF), Deutsche Bank (NYSE:DB) and Barclays (NYSE:BCS). If you still own them, think sell. Unless your investment is a patriotic thing, or a solidarity thing.

There are major ebbs and flows of money from the United States, but a single long term trend, which flows only one direction - toward the States.

There is an old saw, "the grass is greener on the other side of the fence." Yes, the grass is greener over there. That's because someone powerful on the other side of the fence killed and butchered the farmer's cattle, so the grass is unshorn.

What is the relevance to your portfolio decisions tomorrow? In the morning, before the moving pretty charts and news stories flash across your computer screens, and Janis Joplin blasts into your headset, I suggest that you sit quietly with your coffee for a moment. Consider that you might be able to pick long term winners and losers in part, by reading the foreign investment plans reported in the latest earnings announcement.

Are your corporate explainers reporting that they are pulling their assets and employees out of China, Brazil, and Russia? Are their European activities underperforming? When money crosses the border, its return should be part of the plan.

This is not simply an issue to individual investors, but also to domestic corporate managers. The corporate managers that are most vulnerable to the over-valuation of foreign bricks and mortar are inevitably those without an exit strategy. The quarterly analysis should tell you pulling out of Brazil was part of the plan from the time of entry. This thought gnawed at my mind often last week as I listened or read the earnings stories of various corporate representatives.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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