Monday, May 27, 2019

Trade War between China and US is a theater

“I think of it as theater. We have two strong politicians, Xi and Trump. Trump has put these Tariffs on China. It kind of humiliates Xi. This is a human interest story which bleeds over into the markets.”

“We’ve seen volatility pick up right in response to this crisis. But we don't know where this is going. Volatility once stirred does have some persistence, and it could continue for months after this. But it all depends on world events.”

Monday, April 1, 2019

Should we have been able to predict the Bull market from March 2009 ?

Should we have known in March 2009 that the United States’ S&P 500 stock index would quadruple in value in the next ten years, or that Japan’s Nikkei 225 would triple, followed closely by Hong Kong’s Hang Seng index? The conventional wisdom is that it is never possible to “time the market.” But moves as big as these, it might seem, must have been at least partly foreseeable.

 The problem is that no one can prove why a boom happened, even after the fact, let alone show how it could have been predicted. The US boom since 2009 is a case in point.

In looking at the US stock market, it is important to bear in mind that its participants are overwhelmingly US investors. According to a US government study published last year, despite some growth between 2009 and 2017, the share of the US stock market owned by foreigners was still only about one-seventh in 2017. But if all people heeded financial advisers’ counsel and were completely diversified, people outside the US, who held more than two-thirds of the world’s wealth as of last year, would own over two-thirds of the US stock market as well. Home-country bias, or patriotism, is a big factor in the stock market. So, to understand the US stock market’s strength, we need to consider the thinking of its participants.

There seems to have been an overreaction in the US to a temporary drop in earnings. S&P 500 earnings per share had been negative (a very rare event) in the fourth quarter of 2008, both for “reported earnings” and for “operating earnings,” and those numbers were just coming in around March 2009, when the index reached its nadir.

You might think that an intelligent observer in the US in 2009 would have recognized that the decline was temporary, and would have expected earnings – which are relevant to forecasting long-term growth of stock prices – to recover. But the real question is whether the observer could have based a very optimistic forecast for long-term earnings growth on the rebound from that negative earnings moment. We now know that long-term measures of earnings growth did not change a lot. Ten-year average S&P 500 earnings per share from 2009 to 2019 were up only 71% from the previous decade. The quadrupling in the S&P 500 price index was thus driven not by higher earnings but by much higher valuations of earnings.

It is true that real interest rates are down since 2009, with the ten-year US Treasury Inflation-Protected Security yielding 0.8% in February, down from 1.71% in March 2009. But all of that decline occurred by 2010 and could not justify any of the strong uptrend in stock prices since then.

 In 2009, some people in the US were using very strong language to express their fear. One heard that a “financial supernova” was coming. A ProQuest News & Newspapers search for “derivatives” and “financial weapons of mass destruction” (a phrase attributed to Warren Buffett) shows that these two terms first appeared together in 2003 and gained intense popularity by 2009, only to fade to near nothing by 2018.

Those who were prescient enough to know that derivatives markets weren’t going to blow up the economy might have known that any drag on the market from the fear that they would could not be sustained for ten years. But a forecast based on such prescience is hard to quantify or defend publicly.

The fact that economists on the whole had not predicted the 2008 financial crisis was much emphasized at the time and led to some lost faith. Many people were worrying in March 2009 that stocks had a lot further to fall.

Under my direction, the Yale School of Management has been collecting data on the opinions of both institutional and individual investors in the US since 1989. One of the questions is: What do you think is the probability of a catastrophic US stock-market crash, like that of October 28, 1929 or October 19, 1987, in the next six months, including a crash caused by financial contagion from other countries? In early 2009, the percentage of people who gave a probability greater than 10% reached a record high (since 1994).

Likewise, ProQuest News & Newspapers counts of the frequency of the phrase “Great Depression” soared to unprecedented heights. There were more mentions of “Great Depression” in 2009 than there were during the Great Depression.

But then, with no stock-market crash and no extreme depression in sight, these fears were replaced by their opposite: deeper admiration of business success. A new narrative emerged, featuring a new wave of billionaire geniuses whose appearance in the 1990s was interrupted only briefly by the financial crisis. The publication in 2011 of the number-one best seller Steve Jobs,Walter Isaacson’s biography of the Apple founder, is one example. Elon Musk has stirred excitement with futuristic companies such as aerospace manufacturer SpaceX and Neuralink, which is developing implantable brain-computer interfaces.

The accession of a flamboyant businessman, Donald Trump, to the US presidency is evidence of the strength of many Americans’ identification with business heroes. Starting in 2004, Trump spent much of his time developing his business persona as the star of the reality TV show The Apprentice, and then, from 2008, The Celebrity Apprentice. His campaign marshaled this enthusiasm, and his claim that he would “Make America Great Again” appealed to the optimism of US investors.

The quadrupling of US stock prices since 2009, as well as Trump’s election, thus appears to reflect, at least in part, a process of fear abatement and re-enchantment with American business culture. But it is hard to forecast such trends – even the biggest – in the stock market, not only because forecasting is a highly competitive business, but also because spontaneity plays such an important role in human behavior.


Monday, March 18, 2019

People spend a lot of time telling stories

 “A lot of people have that on their mind, and they think it’s got to turn soon. I’m kind of with that. You know, if people think that, they’re going to make it happen."

“People who are good storytellers — like Donald J. Trump is a brilliant storyteller — they tend to rise in our economy. He models a general public support for business, cuts profits taxes — what more can you ask?”

“That attention to public debt has waxed and waned throughout history. It seems like the public is OK with it for now. But I think in the back of their minds they’re not so sure.”

Tuesday, February 26, 2019

High risk of recession in 2019 or 2020

"It seems like there has to be an elevated probability of a recession this year or next."

Wednesday, January 23, 2019

Jack Bogle is a hero of mine

The death on January 16, 2019 of Jack Bogle, the founder of the investment company Vanguard Group, was met with a slew of flattering obituaries. Of course, obituaries often praise their subjects. But Bogle’s seemed more laudatory than usual. And I think there is a reason: Bogle was an unusually morally directed man.

Of course, we cannot judge his success by his personal wealth. When Bogle established Vanguard in 1975, he set it up as a nonprofit. The company has no outside shareholders; all profits are reflected in lower fees, not dividends.

By metrics other than founder wealth, the Vanguard Group is a huge success. It invests for 20 million people in 170 countries. It has $4.9 trillion in assets under management. It may be the world’s most significant investment company.

But this does not mean that we must agree with everything Bogle said, or malign others who are not nonprofit. His is not the only way to be moral.

Bogle’s morality was rooted in his conviction that trying to beat the market is futile. This was reflected in his 2007 book The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. His investment strategy is “the only way,” and the opening paragraph of the tenth-anniversary edition sums it up:

“Successful investing is all about common sense. As Warren Buffett, the Oracle of Omaha, has said, it is simple but it is not easy. Simple arithmetic suggests, and history confirms, that the winning strategy for investing in stocks is to own all of the nation’s publicly held businesses at very low cost.”

This means that one should simply invest in an index fund that represents the whole market and then call it a day. But it is a little odd to be quoting Buffett in support of such a strategy, given that the Oracle of Omaha owes his fame (and his moniker) entirely to his ability to outperform the market.

Bogle’s statement is best interpreted as applying to his audience of individual retail investors. Because the market portfolio is the average investment for all investors, the average investor can do no better than the average for the market. But the excitement of the market causes people to lose sight of that. As Bogle puts it in his book: “The stock market is a giant distraction from the business of investing.”

He is right about the distraction. People look for excitement, and the stock market is one game they can play. People will gamble anyway, if not in the stock market, then in a casino. On the other hand, it is no doubt better overall if people learn lessons about business and real economic activity, rather than card-counting tricks. There may be rough rides for some, but the hurly burly of the stock market is also a sign of a vibrant economy.

Advising people simply to hold the market is advising them to free-ride on the wisdom of others who do not follow such a strategy. If everyone followed Bogle’s advice, market prices would turn into nonsense and would provide no direction to economic activity.3

I remember exactly when I began to appreciate the complexity of the moral issues money management entails: October 8, 2009. I received a phone call from the eminent MIT economist Paul Samuelson, who had been my teacher when I was a graduate student in the early 1970s. He was 94 years old at the time, and two months later he died. I was so impressed by the call that I took notes on it in my diary.

Samuelson was responding to my recent publications advocating expanded insurance, futures, and options markets to mitigate the financial risks – for example, those related to housing prices and occupational incomes – that ordinary people face. He said that these markets could, if pitched to the general population, turn into “casino markets,” with people using them to gamble, rather than to protect themselves.

He then brought up the example of Bogle, who “gave up a billion dollars for a concept,” Samuelson said. “He could easily have cashed this in,” but he didn’t. “The miracle that was Vanguard came from Bogle’s principles.”

I thought he was right. In the long run, markets reward principled people. But there is still need for an expanded set of risk markets, because these markets can – and do – carry out useful functions, including risk management, incentivization, and orienting business.

The problem is that attention to these markets requires intelligent and hard-working people to help others in their investing. Theirs is not a zero-sum game, for they help direct resources to better uses. And these people must be paid. Even Vanguard, which now has a number of different index funds, hires investment managers and charges a management fee, albeit a low one.

Not every fund needs a low fee. We live in a world where constant and rapid change and innovation require more attention, and attention is costly. While many financial managers are at times unscrupulous, a higher management fee is not always a sign that something is wrong.

But Bogle is still a hero of mine, because he provided an honest product and was motivated by a sincere desire to help people. And he should be a hero to all, because he showed that markets eventually recognize integrity.

via projectsyndicate