Tuesday, January 30, 2018

Greatness from Megan McArdle

The most indispensable blogger we have.

At 43, I understand EXACLTY what she means.

https://www.bloomberg.com/view/articles/2018-01-30/megan-mcardle-s-12-rules-for-life


Tuesday, January 23, 2018

US Household Assets by Net Worth

This is a great graphic by Visual Capitalist.  You can see how assets are spread across income groups.  Note that this Makkimoto chart shows the relative distribution across groups, it doesn't show the spread of total assets or of the size of the groups (it would be cool if the vertical dimension were used to have the areas correspond to the actual amounts, but probably the top group would become very hard to distinguish.

http://www.visualcapitalist.com/chart-assets-make-wealth/

Not surprisingly, less well off folks have a greater share of their wealth in liquid assets (everyone needs some cash and checking) and in "use" assets, those assets that, while they have financial resale value, are really a form of consumption (transportation and shelter).

It is also pretty clear that if you want to be really wealthy, you need to have a successful business in which you are a significant shareholder or control person.  Since large, successful businesses are pretty rare (even small successful businesses are tough to operate, I speak from experience here, but will start another business soon), very few people can be truly rich.  But passive investments, particularly cashflow real estate (which is also a business but except for skyscrapers or PUDs are also small) can make you quite comfortable.

You have to think about your personal strategy and what you want.

Friday, January 19, 2018

The future of returns: an ongoing series

Long time readers know that I am pretty bearish on the ability of investments, as a whole, to earn historical rates of return.  It would be nice, of course, if they could, since with low inflation, high rates of return would mean an increase in *real* returns and the ability to fulfill the fantasy that we can all be rich.  Just put a little bit aside every week or month and watch the power of compounding make you a very comfortable person.

Logically, though, this is impossible, since as "everyone" did this, competition for goods, services and assets would drive prices higher.

Alas, among the most fanciful are the most "sophisticated" investors - pension funds.  Public pension funds have a major weakness, they are run by politicians and public employees, who desire attractive work conditions: easy jobs, comfortable pay, job security, and cushy benefits like attractive pensions.

Politicians like to give this constituency what it wants (see Megan McArdle on this topic) but prefer taxpayers not know what this costs.  Since many of the actual costs can be shifted to the future (for a different electorate and politician set to deal with and when later pols can deny responsibility) assumptions about the future tend to be pretty rosy.

Here is Jason Zweig, one of the best financial journalists we have, writing about this topic.

Happy do discuss in more detail.

Monday, January 15, 2018

From the Screen of the Strategic Investor

Philosophical Economics has a really nice essay on returns and what investors can expect going forward.  The news is bad.  We concur that returns are likely to be well below the experience of the past 40 years, even taking into account that the decade from 1999-2008 was truly abysmal.

For many reasons, valuations in 1999 were at absolutely incredible levels.  Valuation-indifferent buyers of equities, largely focused on low cost index products, who have to buy every month because of the need to save for retirement are a major factor.

We believe that many historical rates of return are driven higher by one time factors that will not recur and therefore, we will see a significant revaluation, which will punish investors (particularly GenX and particularly early cohorts).

Note that the author has not accounted for changes in tax policy.  Over time these things are somewhat cyclical, however, markets tend to experience significant downward valuation as taxes rise (since it reduces earnings and EPS, and also because it discourages redeployment toward better uses and finally because, investors care about their real after tax return and if you raise taxes, then the nominal pre tax return must go up to provide stable after tax returns and this means prices - at least relative to earnings, have to decline).

Sunday, January 14, 2018

Stephan Co - My Seeking Alpha Write Up

At the urging of a friend, I published a write up I did on one of the stocks I own on Seeking Alpha.


If you are interested you can read it here.


Wednesday, January 10, 2018

From the Screen of the Strategic Investor


Thought I would start a set of daily links.  In part, this helps me keep track of them (though of course, I also have favorite lists and folders) and also because some of these are really interesting.


Investments and Valuation:

CAPE naysayers are wrong.  Arnott and his crowd discuss the evolution of CAPE over time (generally higher) and consider return to the mean.  Smart guys.  They are aware of the threat of valuation indifferent buyers and sellers.

Is the bond market finally about to swing back into a long-term bear market?  Seems tantalizingly close, but then global rates are low and demographics seem likely to create valuation indifferent buyers here, too.


Economy

Are we at the top of the job cycle?  This is a non-trivial question.  Seems pointless to create lots more jobs when there aren't enough workers.

Tuesday, January 09, 2018

Contributions to Clintons dropping?

This is not a political blog, but we like to look at businesses of all kinds.  Charities are a special kind of business - a business in which value provided to end users is less than the cost of the inputs of that value, necessitating continuous access to capital.  Government supports that access through favorable tax treatment (either at the organizational level, where an organization itself pays no taxes on its inflows) and/or at the donor level.

One of the largest charities in the United States is the Clinton Foundation, which during the presidential campaign came under mild scrutiny for being a (taxpayer supported) campaign in waiting and for offering opportunities for foreign and domestic interests to buy access to the Clinton family and therefore indirectly the White House.

The Clintons insisted that this was all simply due to the unique scale and reach of the Foundation which enabled (big money) donors to write one check and have significant impact.

The telltale signs would always be, what happened to donations if Hillary lost.  Absent future access to the White House, would the donors keep giving?

The first results are in and they suggest that interest might be falling.  In November 2017, the foundation finally published financials for 2016.  Comparing them to 2015 indicates that there have been a decline both in receipts and also in the balance sheet (assets).  It will apparently be another year before we get the details on 2017, but isn't it simply interesting that 2016 was down about 15%, which is about 6 weeks of the year, or about the amount of time between election day and December 31.  Could it be that funds just dried up on November 9, 2016?  Only time will tell.

Interestingly, though, the "Clinton Health Access Initiative" CHAI, made a decision on March 7th, 2017 (a subsequent event to the released financials) to change its governance.  Prior to that date the Clinton Foundation appointed five of the nine members effectively controlling the charity (and so it was consolidated).  Thereafter, the Clinton Foundation is entitled only to "recommend" five members to an expanded board of 15, with the other 10 members being recommended by the independent board members, and with the charity then ratifying the entire slate (or not).  Thus, the charity is no longer controlled by the Clinton Foundation and will be deconsolidated (indeed, it will cease reporting).  This takes about $152mn of revenue (from a total of $222mn) out of the picture.  It effectively reduces the scale of the Foundation by 68% on a revenue basis and about 21% of the assets.

Many postulates are possible here - perhaps in a post-campaign world the Clinton team no longer have enough human resources to staff the larger institution.  Perhaps fundraising will be easier if there is more separation from the Foundation?  This would make sense if most of the donors up to this point saw the charity less as a civic duty and more of an influence buying vehicle.

This is one of the perils of having a business that has a moat which is heavily dependent on the personal assets of the people running it.

Thursday, December 18, 2014

FMOC Statement

David Merkel of the Aleph Blog publishes a redacted FMOC statement with his own commentary after every meeting.

It is required reading at the Strategic Investor.

David, I think it is fair to say, is sceptical of the wisdom of committees of academic central bankers.  He is also a critic of the wordiness of the Fed Statement.  He believes (rightly, in my view) that in the effort to be clearer, the Fed has introduced lots of commentary on current conditions and the effect has been to reduce clarity, because the economy is a complex system about which it is difficult to make conclusive judgments.  Thus, the Fed highlights various uncertainties and often confuses the public.  A growth in 24/7 financial media which desperately needs something to talk about multiplies this as they attempt to parse every word.  I digress.

While I share much of that scepticism, I think that the narratives have become too rutted and categorical - as in - QE is great, the only problem is there  hasn't been enough and QE is bad, inflation is coming.

I think there are some other views of QE that should be expressed, and so I sent David an email, which I reproduce hereafter.

Broadly, I think that in terms of unemployment and combating deflation, QE has largely been ineffective.  This is by design.  Let me say it clearly, I do not believe that the underlying logic of QE is the dual mandate of the FOMC, but rather serves the regulatory function of the Federal Reserve, ensuring that sound institutions are able to operate.  QE hasn't obviously helped employment much - while employment has been rising, this has not been due to large amounts of credit expansion.   Moreover, it has not led to inflation.  This should not surprise us, as the Central Bank went to Congress at the outset of QE I and asked for permission to pay interest on reserve balances at the bank, which enabled the Fed to sterilize its new "money" by ensuring that the banks would keep it all at the Fed and not relend it.

What QE has done are two things - first, it has reduced the interdependency of the banks and banks' dependency on the money markets to provide short term liquidity.  This means that for the time being, there are likely to be fewer credit shocks that threaten any bank of size and that even if one bank is hurt, that the others are well insulated.  Thus QE allows the Fed to support the banks and protect the banking system while the banks build capital required in 2019 under Dodd-Frank.  It does so in a way that voters and perhaps Congress don't see, so it doesn't get labelled a "bank bailout".

The other thing that QE has enabled is for the Federal Government to run large (temporary) deficits without raising interest rates.  This might have been a problem over the period 2010-2012.  But should be be surprised that as the deficit has declined by $600bn per year since 2013, that the Fed has reduced its purchase of Treasuries ($45bn / month) by about the same amount?  The effect has been to bridge the government while the "core" buyers of treasuries, who were prepared to snap up $500bn of the things at "low rates" while the Fed was exercising QE are similarly prepared to accept similar rates for a similar volume of bonds today?  This is the real reason rates haven't risen.

Quite frankly, I think the Fed executed this move far better than anyone imagined.

Given that, I expect that in spite of short term volatility driven by Fed comments, that the economy will continue on about the same course for the forseeable future.

Below my letter to David, and hopefully a response from him.

I can understand if you are sceptical about Central Banks.  They are human constructs, and as such make mistakes.  But quite frankly, none of the doomsday scenarios appears to have occurred (I realize that fear that developing markets will experience a credit shock as a result of Fed tightening is possible).

Your specific criticisms have generally been of two sorts: first, that the Fed can’t really do anything about employment and therefore that we should expect no impact, and second, as today, to decry that the Fed’s policy hasn’t fixed anything and that unemployment is still horrible.  It seems to me you are trying to have it both ways - blaming them for taking action AND blaming them for not fixing the problem.  Which is it?  Or do you simply believe that the economy would have recovered faster without QE?  I think there is a case to be made here, but then make a case that QE has been harmful, not simply ineffective.

(FWIW, the case to be made is that to the extent that in a debt deflation savers are the consumers with the highest marginal propensity to spend, so don’t cut their income, because borrowers - who are largely overleveraged - cannot offset the belt-tightening by savers who find the yield on their savings cut).  Not really sure if it is true, but it seems possible.

I tend to lean in the direction of your first criticism - that the policy has largely been ineffective, at least by the metrics outlined in the FOMC.  Unemployment AND inflation are impacted most heavily by an aging society.  Retirees like low prices, tend not to spend and don’t like to work.  That the participation rate would decline after 2008, as demographic Boomers started being able to collect social security and tap into retirement plans is unsurprising.  In fact, to the extent that asset prices have risen (we can debate the extent to which the FOMC is responsible; I am a sceptic) we are ENCOURAGING lower workforce participation, as near retirees and those over 62 see a recovery in their nest eggs.

In other words, the Fed is getting the blame for a demographic challenge known since the late 1970s and quite frankly, one global in nature as fertility falls worldwide.

My own view, as I have stated before, is that QE is actually a bridge to Dodd-Frank.  What I mean by that is that banks have to build capital buffers to prevent insolvency, but they have until 2019 to do so.  In the meantime there is more than a bit of risk that a credit crunch could, through counterparty interconnectedness, lead to another infection of the banking system.  To avoid this, the Fed has built up massive Federal Funds at the banks which enable them to have a ready source of “safe” assets to trade with the other banks, and they can avoid resorting to commercial paper and other forms of short term financing.

After all, if the intent of QE were to actually flood the economy with cash, as many believe, the Fed would not have gone through the process of securing Congressional approval to pay interest on the reserves (thereby sterilizing them and preventing them from being fuel for new credit).  This also explains somewhat why the impat has been muted.

Friday, July 12, 2013

More evidence that China's rise is not inevitable

Some time ago, I wrote a post about three China predictions, in which I argued that China was likely to become the worlds largest economy due to some basic factors in its economy: it was growing in real terms, it had positive inflation and had a nearly fixed exchange rate to the dollar.  This means that in dollar terms the inflation China experiences counts toward its economy's size (unless you measure in PPP).

I also suggested that longer term, China would be surpassed, not only by India, but also again by the United States, which simply has better fundamentals.

Recently, there has been mounting evidence that China's rapid boom is coming to an end.  Today I saw this, which shows that the evidence is now so compelling that it is turning even the general media's narrative.  In the short term, China will likely take the steps necessary to keep the economy growing at a 5-6% rate.  Premier Li has already indicated that 8% is no longer the target (and with a declining workforce, is most likely unattainable).

These are growth rates to which India can aspire (it needs to make some structural changes in its economy).  Indeed, India has at times exceeded these levels and could do so again.

Meanwhile, the US can keep chugging along at 2-3% and remain larger than China on PPP terms for a very long time.

Good news for China, however, is that the absorbtion of cheap labor means it can focus more on quality of the labor, and on quality of life, as it moves up the income scale.  Bad news is, most countries fail when they get caught in the middle income trap of too many skills (and too high prices) for cheap work, but not enough skill for higher wages.

We shall see, but I believe that if you work or invest in businesses / industries that rely heavily on Chinese growth to function as an escape valve (or as the primary driver of growth), you have to be very concerned that many of the capital investments undertaken to capture Chinese market growth may be written off.  The risks are rising that this will happen.

The Federal Deficit: The REAL Reason the Fed will Taper

In the media, there has been much knashing of teeth over the scaling back of QE3.  Supposedly, the move to reduce purchases of US Treasury securities will lead to higher interest rates and from there to recession and then armageddon.  It is a delightfully linear thesis, which means it plays well in the media.  Ironically, much of the moaning comes from the same people who moaned about the introduction of QE to begin with (distorting the markets, perverting risk/reward, and eliminating price signals for investors).  So, QE is terrible, but withdrawal is worse.  One wonders what the addict is to do.

The Fed has maintained all along that factors in the economy overall would be dispositive, and highlighted unemployment (as part of the "dual mandate") as the main driver.  While labor markets have been improving (creating over 200,000 jobs per month for the past year and showing more strength this summer), there is another factor that is surely starting to come into focus: a dwindling supply of newly issued Treasury paper to buy.

A year ago, when the Fed started buying $45bn a month in Treasury securities, the Federal government was running a deficit of almost $100bn a month.  Thus, the Fed was buying about half of all newly minted securities, leaving the public (and foreign central banks) to buy the rest.

Due to several positive factors released in the monthly Treasury statement yesterday, including rising employment, higher corporate profits, higher rates of tax on incomes and the end of the payroll tax holiday driving higher revenues, and the sequester and the military drawdown leading to lower spending, the deficit is shrinking rapidly.  If CBO is right, the deficit will be about $640bn in FY2013, or $500bn less than the previous year.  (The same teeth knashers are suggesting that the economy is suffering from the withdrawal, though this doesn't seem to be true.  Makes you wonder how important all that "stimulus" really is.  I digress).

Were the Fed to keep purchasing at the same rates as before, it would purchase effectively 100% of new issuance, leaving no bonds for pension funds, and others looking to match assets with long term liabilities.

Indeed, to maintain this pace, the Fed would very soon have no choice but to purchase off-the-run bonds from prior periods of issuance.

This is why the Fed has moved off of the 6.5% unemployment figure that was its target for tapering before.  Mind you, reducing its purchases by half, to maintain its share of overall absorbtion of new Treasury issues will still leave a much smaller pool of assets for private parties.  In fact, if private demand reflects the $50bn or so the Fed was not buying each month in the fall of 2012, then the Fed would have to cut to zero just to maintain a large enough supply to feed the private market.

This is also why this is a great time for the Fed to "exit" or "taper" purchases.  Supply is more in line with private demand.  If the Federal government can manage a second and third round of sequester controls, along with some modest tax reform, the budget could realistically be in balance in FY2016.

Even if the deficit remains in the $200bn range, the Fed will have the option to sell some of its off-the-run bonds into the market to meet the demand of investors for bonds.  (With a balanced budget, the effective buyer could be the Federal government which could redeem the bonds at par).  All of which means that Bernanke might have been right all along.  There may be some capital losses associated with this.  But done moderately, the incredible interest generated by the portfolio will help to offset this.

Now, on the mortgage market side, things might be somewhat different.  However, again, as natural supply of Federal debt securities decline, investors looking for long term income will need to migrate to other asset classes with the most similar risk/reward characteristics: e.g. mortgage securities.

It will be fun to watch the knashers complain about how QE didn't really work, it just "got lucky" as policy was enacted as the economy was taking off on its own.