Archive for March, 2010

Heat Chasers and Happy Meals

March 31, 2010 Comments off

Investors chase heat. In and out of every market cycle, it never changes and is always fascinating to observe. Lately, I’ve heard a lot of investor questions to the effect of, “Why not load up the portfolio in more Emerging Markets?” After all, as a category they represent more than a quarter of global GDP, and their burgeoning middle classes—who are ramping up consumption on materials, goods, and services—are driving much of 2010’s economic growth.

Fair enough, but remember these are still developing economies. We often take for granted basic ideas about property rights, highly liquid equity markets, and so on. But if you think 2008 was scary with all the government interventions and confiscating of assets in places like the US …well, that kind of risk is on the table daily in most developing regions. As with all things, there’s a risk/return relationship. Emerging Markets right now has, on balance, tremendously attractive fundamentals and promises great performance…but the flip side is the basic risks of Emerging Markets are still there. For instance:

Google Runs Into China’s ‘Great Firewall’

Yuan’s Fair Value Debated Inside and Outside China

These kinds of issues remind us a place like China is still a communist command system. It’s not a great basket for all or even a significant amount your eggs, in my opinion. Chinese officials can make huge, punitive, protectionist, and property-damaging moves at a whim. Should that happen, you don’t want to have too substantial a component of your portfolio in an asset the state might wipe out.

Then again, China now has its very own “Hamburger University”, courtesy of McDonald’s. That’s a small bit of evidence atop a heaping stack that points to a bullish case for Emerging Markets as a category—China has, pardon the pun, millions of hungry consumers.

All this begs an important point about developing markets: all this talk about China …where’s the love for the rest of Emerging Markets? I don’t hear nearly as much about places like Brazil , which features rapid growth, rich natural resources, and a more liberalized economy than China . Scour the globe—there’s a lot out there besides just China .

No matter how sure you are about anything, always know you could be wrong, and never break the rule of diversification relative to an appropriate benchmark. That rule will save you from too much heat chasing. My preference for anyone with a long time horizon and needs stock-like returns: A global index, cap-weighted, like the MSCI World Index or similar. Absolutely look for opportunities in thedeveloping world, just don’t take it too far.

The Fed Might Be Out, but Government’s Not Done with Housing

March 30, 2010 Comments off

A big worry in front of investors today is what happens to US housing once the Fed’s program to buy mortgages expires (it’s happening this week).

It’s not clear housing performance is much correlated with other asset prices in the first place. After all, bull/bear cycles in equities don’t match up well with housing boom/bust cycles. Additionally, if you expand your view globally (knowing that global stock markets are highly directionally correlated), US housing doesn’t look so big and bad in context for the world economy (both US and global GDP are rebounding nicely without a housing revival).

But even if you don’t believe any of that, there are plenty of reasons to question whether the Fed’s exit means housing’s re-demise. Here are three articles of note:

· Cheaper Mortgages May Linger as Bond Investors Take Over When Fed Departs

· Mortgage Increases Blunted

· Subprime-Mortgage Debt Rallies as Treasury Boosts Loan Aid: Credit Markets

Essentially, just because one Fed program ends doesn’t mean the government’s role is finished. Also, between loan modifications (a dirty business, no doubt), and materially lower interest rates today for resetting adjustable loans (ARMs), I believe there isn’t as much to fear as, well, first feared. Also note that just because the buying program ends doesn’t necessarily mean the selling program begins. My guess is the Fed and its respective tentacles (hello GSEs?) will hold those mortgages for a long time—many probably to maturity.

Lastly, there are signs—not terribly robust, mind you—that housing prices are regaining some footing. Home prices according to the most recent Case-Shiller index (an index for which I have my doubts…just 20 cities???), showed slight improvement. Note too, there are a lot of other distorting elements in US housing right now—the Obama tax credit which originally would have expired in November now has a deadline of June 30, so housing may see some marginal benefit over the next months. Then again, many of those in a position to take advantage of the tax credit may have already done so before the original deadline.  Who knows.

In sum, my view is the Fed’s exit does put some upward pressure on mortgage rates, just less than first feared. But ultimately, these features are widely known, and markets have expected worse than this for a long time. When things aren’t as bad as feared is when markets tend to pop—and the last several weeks (not to mention the last year) have been great evidence of that notion.

Signs the Apocalypse Has Been Cancelled

March 29, 2010 Comments off
  • Useful factoid: as of Friday, the S&P 500 was up 5.1% for the quarter. If it doesn’t lose any ground from now to the end of the month (today was a nice up day as well), it’ll be the best Q1 return for the S&P 500 since 1996 (+5.4%). (Source: Global Financial Data, Inc.)
  • Consumers in the US keep spending: Consumption rose in February for a fifth consecutive month. This is without a big rebound in employment so far—which is almost totally contrary to the intelligencia’s normal view of how a recovery ought to work. Personal income was virtually flat m/m but rose +2% from a year ago. All this in the context of a very low inflation environment.
  • 2009 was so “too big to fail”. We’re over it. 2010 is all about…too big to succeed! If this isn’t a shining example investors have capital and are looking to put it back to work, I’m not sure what is…

Fisher Investments Analyst’s Book Review: Attack of the Quants!

March 26, 2010 Comments off
Books about “quants” are popping up everywhere, but Emmanuel Derman’s My Life as a Quant is best for neophytes.

Hedge funds are blamed for a lot of stuff these days. Open the paper and you’ll find regulatory head honchos across the globe recommending a ban on CDS (credit default swaps) and the like. Fisher Investments feels hedge funds and their black magic math are getting blamed for everything from the panic of 2008 to today’s Greek debt woes.

Fisher Investments believes the speed of capital markets’ development in recent decades inherently makes folks nervous—new and highly sophisticated products are based on complicated mathematics that aren’t intuitive (let alone comprehensible) to the lay investor. So it’s natural investors want to know who these folks are and what they’re up to, and it’s also natural to fear them. We tend to fear what we can’t understand, and populist media will happily stoke the fire. The more sensationalistic of contemporary quant books want to equate the strategies of all hedge funds (and the ubiquitously nerdy, greedy quants who run them) to a wanton, drunken night of Vegas gambling. Instead of making that point convincingly, these books are instead unwitting caricatures of how average folks tend to misunderstand this part of capital markets.

But Emmanuel Derman—one of the original quants—is not someone to fear, or distrust. His fantastically wrought My Life as a Quant: Reflections on Physics and Finance is a must read for any non-professional wishing to learn more about what quants are and how they do their job. Mr. Derman tells his tale in the form of a memoir: He starts as an ambitious theoretical physicist, but ends up on Wall Street in the mid-eighties, pioneering mathematical and computer programming breakthroughs—innovations that have since revolutionized capital markets.

The tale is told with tremendous deftness and aplomb—the tribulations of Mr. Derman’s life are presented with restraint yet are touching and universal. Through his narrative he weaves explanations of math and physics—of the most technical and flat-out-boring sort—in so simple and readable terms that a person with no background in such matters will come away both more learned and entertained. I’m willing to bet even the neophyte will grasp the Nobel Prize-winning Black-Scholes model and the problem of the “volatility smile” in pricing stock options. Really!

Here you will read about the origins and development of the quants on Wall Street, why those with highly theoretical backgrounds in physics and mathematics prevailed through this era, and what exactly they were up to, sans overt drama, politicization, or sensationalism. Readers will also come to appreciate that, along with math, this is the era where computer programming transformed all of finance.

In his heart of hearts, Mr. Derman is an academic, and he spends time talking about the personal and professional conflicts in making the transition to Wall Street. There is great humor here (they work 50 hours a week, lunches are always catered, and all that matters is the bottom line!), but it also makes for great perspective. Perhaps because of his experience in both worlds, Mr. Derman transitions between the aesthetics and beauty of theoretical math to the forced pragmatism of the market’s irreducibility lightly and easily.

The final chapter is a tour de force in the problems of dealing with models/theories versus reality. For anyone who believes in the primacy of mathematics as a mechanism for “figuring out” markets, Mr. Derman will put those notions to rest convincingly. Math is a description of reality, not reality itself, and therefore no model will ever describe how markets work in an ironclad way. Instead, what happens in real life (what the academy calls “phenomenology”) must drive finance—because it’s ultimately as much a social science as a natural one. At least for today, the human element cannot be so easily reduced to an equation. (For the truly brave and adventurous willing to sink their teeth into modern philosophical debates about math, I recommend Where Mathematics Comes From: How the Embodied Mind Brings Mathematics into Being by George Lakoff and Rafael Nuñez, or Is God a Mathematician? by Mario Livio. But don’t say I didn’t warn you—it’s heady stuff!)

But whatever you do, don’t let contemporary rancor blind you to the importance, beauty, and complexity of today’s capital markets and their instruments—they are a wonder to behold, and ultimately a boon…even if sometimes they bust.

*The content contained in this article represents only the opinions and viewpoints of theFisher Investments editorial staff.

Take 3 Thursday

March 26, 2010 Comments off

1. This is beyond amazing. From the guys who said “New Normal” last year. Now they’re bullish on stocks!

2. A great, if snarky, view on US banks and moral hazard. One of my favorite lines of the year so far:

“Not only is the federal reserve subsidizing the replenishment of your bank’s [Bank of America] capital by confiscating yield from savers/depositors so you can earn monstrous spreads on your loan book, but now you are rewarding those who bit off more than they could chew, while those who did not take on excess leverage, or who kept their income-to-debt ratios manageable, see no benefit, even as their home equity values have declined.”

3. The plight of many traditional forms of media over the last decade has been a major contributor to the pervasive pessimism of this era. After all, if you were a journalist and saw a decade straight of your industry getting chopped down, and many senior editors getting laid off, you’re a lot less likely generally to see the world as a great place these days. It’s all doom and gloom.

They Missed It Again

March 24, 2010 Comments off today published an enlightening survey:

Americans Say They Missed 73% Rise in S&P 500 as Economy Surged

by Mike Dorning

A couple of my favorite parts:

“By an almost 2-to-1 margin Americans believe the economy has worsened rather than improved during the past year, according to a Bloomberg National Poll conducted March 19-22. Among those who own stocks, bonds or mutual funds, only three of 10 people say the value of their portfolio has risen since a year ago.”


“A sense of despair pervades perceptions of the economy and nation. Barely one-in-three Americans say the country is on the right track. Fewer than one in 10 say they believe the economy will be strong again within a year. Just 4 percent of Americans who cut back on spending during the recession now say they are confident enough to open their wallets, according to the poll, which has a margin of error of plus or minus 3.1 percentage points.”

Indeed, for as bizarre and brutal as the bear market was, this is prototypical behavior in the beginning stages of a recovery. Stocks tend to recover before the economy, leaving those who believe “it’s different this time” with light pockets after the first year of a bull. It’s tragic because the biggest gains in bulls tend to be front-loaded in those first years where disbelief is most prevalent.

Who Says Housing?

March 24, 2010 Comments off

If the last few quarters haven’t been ample evidence the economy (and stocks) can recover without the housing boom, I’m not sure what would be.

According to The Wall Street Journal, sales of existing homes fell a third month in a row in February. Home resales are sitting at about a 5.02 million annual rate—basically halved since the peak of the boom. Meanwhile, new home construction also remains anemic at an annual rate of about 575,000. At this point things are perhaps stabilizing for housing, yet, second estimate Q4 2009 GDP came in at 5.9% (the final one will come in a few days).

With residential housing construction now at a mere 2.5% of GDP, I believe looking to housing activity as a catalyst of recovery is more of a populist thing than a substantive one. (Theoretically, you could wipe out the whole thing—literally take it to zero—and still have GDP growth.)  I do have some sympathy for the notion that housing velocity spreads its tentacles into many parts of the economy—fees, taxes, materials, moving costs, and so on. But the basic GDP breakdown overwhelmingly shows what matters right now is the recovery in business spending and net trade activity—both of which are currently recovering in V-shape fashion. And that makes sense because those fell the most during the recession. Believe it or not, consumption doesn’t matter that much right now because it never fell that much to begin with. And, well, higher government spending is a given for the foreseeable future.

You can see it all in the most recent release on US GDP from the BEA (Bureau of Economic Analysis). On this kind of thing, try to get the data straight from the horse’s mouth—not through the lens of a newspaper journalist or third party. And be on watch for the final revision to Q4 ’09 GDP next week.

Sources: Wall Street Journal, National Association of Realtors, BEA

The PPIP Petered Out

March 23, 2010 Comments off

Sometimes it’s what doesn’t happen that matters for stocks and economies. One of our Financials analysts at Fisher dug up this little factoid today:

On 03/23/09 the Federal Reserve, FDIC and Treasury announced the Public Private Investment Program (PPIP), which was originally intended to support the purchase of $500 billion to $1 trillion of legacy assets. A year later the Legacy Securities Program has supported investments of just $30b while the Legacy Loans Program has yet to be implemented. It looks like this piece government-backed financial stabilization spaghetti didn’t stick.

The lackluster results are probably due to the banking system’s ability to recapitalize on its own over the last year. It’s hard to overstate what a colossal show of capital markets strength this is just a year since the panic abated in 2009. It’s also a show of how successful other stabilizing programs probably were (some are actually making money for the government!), and the relative strength of the economy outside Financials.

News is usually about stuff that happens—editors don’t generally care for what doesn’t happen. In this case, nothing was a great thing.

Sources: Treasury and FDIC

Fisher Investments Analyst’s Book Review: I Am the Walrus (Goo goo g’ joob)

March 19, 2010 Comments off

Sean D. Carr’s The Panic of 1907 illustrates just how familiar—and also different—the events of 2008 really were. A truly mind-bending trip, man.

Book Review -- Michael Hanson

J.P. Morgan is one of the most fascinating and important characters in all financial history. Yet, every time I see him, I can think only one thing: he looks like a walrus.

It’s that big bushy mustache. (See the photo above.) And when I think of walruses, I think of the Beatles’ trippy tune, “I am the Walrus.” Legend has it the walrus in question references Lewis Carroll’s “The Walrus and the Carpenter” in Through the Looking-Glass. Lennon later said he had Allen Ginsburg in mind after a series of acid trips, but he ultimately regretted choosing the walrus at all because Carroll’s allegory is about capitalism, and the Walrus is the villain. Go figure.[i]

That strange loop of interconnection takes my mind to Sean D. Carr’s ThePanic of 1907—an account of a truly mind-blowing era in capital markets history, where Mr. Morgan, the Walrus himself, was the hero. Morgan was in essence the first Fed chair—at a time without a Fed. He was the dominant banker of the era and a legendary dealmaker, which made him thede facto financial leader folks looked to when trouble hit. He was not only the first sort-of Fed chair, but the most famous one by far until we get to Volcker and Greenspan in the early 80s. (He even mentored the first real Fed chair, Benjamin Strong, a prominent Morgan banker and one of his right-hand men in the panic.)

1907 features scintillating stories of daring do! J.P. himself can be seen hastily making his way on foot through the streets of New York—to the cheers and hisses of those who recognized him—to meetings in dark, smoky rooms where the fate of US banking hung in the balance! Even a midnight train was commandeered for the US Treasury Secretary (at the behest of Teddy Roosevelt himself!) to consult Morgan first thing in the morning and save the system![ii]

Indeed, the Panic of 1907 is high financial drama of the first caliber, which makes it all the more amazing there isn’t a whole lot written about it for the general public. That’s probably because it’s before what many consider the “modern era” of investing (somewhere in the mid- to late-20s), and thus such events feel too archaic and don’t get as much attention. The “Middle Ages” of finance if you will.

This is a shame and also mostly false. Capital markets at the turn of the twentieth century were burgeoning, dynamic, and free-wheeling. Juggernauts like the Rockefellers, Carnegies, and others are fighting the trustbusters, the industrial revolution is taking the western world by storm, and the US is getting set to emerge as a world superpower. While it is true that data is shakier and less available so far back, the basic mechanisms of banking as a social function—to allocate capital efficiently, that is, to take in deposits and lend longer term—are very much the same as today and worth our study.

Carr’s concise and accessible book— you can knock it out on a longish plane ride and all the financial bits are in laypersons terms—gives us a sense of that. He tells a good story in the first half; above and beyond what’s normally reserved for analyst/academic fodder. Then he offers economic analysis in the second, featuring a smattering of appendixes on various topics for the econo-phile in you. (There’s even a quirky little appendix in which Carr investigates the many definitions of what a “panic” actually is.)

The concluding chapters offer an analysis of common features of market panics. In this, Carr is sometimes spot on, other times less so. One highlight is Carr’s adept use of the “prisoner’s dilemma,” a common theoretical problem of game theory, to see the real world choices a banker and/or trader must face when liquidity evaporates, often creating a vicious cycle. But he is right to put himself through such paces. The real value of this book is its clear depiction of human behavior—that is, the most repeatable element in market cycles. Times change, and at an accelerating rate—tomorrow will never be the same as yesterday. Yet comparing a hundred years ago to now, we see how consistent human behavior is. Greed/fear; love/hate: Carr’s storytelling shows those things don’t change no matter how much capital markets evolve.

1907 lacked today’s sophisticated financial and economic theory, today’s hardcore mathematics, all the investing products we have at our fingertips now, the information readily available to us. But when it came right down to it, a crisis in confidence and banking woes sparked a liquidity squeeze and panic that shook the whole system. That’s more or less the story of 2008. Such eras of turbulence are often catalysts for regulatory change. 1907’s events were the impetus for creating the Fed, and called very much into question the notion of the gold standard. Again, today’s regulators vie to overhaul the financial system—a key political issue of 2010—and some are even questioning our dollar-centric exchange rate system of fiat currencies.

To some, the world is as psychedelic, chaotic, and disassociated as theMagical Mystery Tour. But if you study the lyrics enough, an undercurrent of repeating patterns and meanings emerges. 1907, like 2008, was market vertigo, but the human response was archetypal. Goo goo g’ joob.

[i] Of course, when it comes to Beatles lore, there are a thousand different tales and explanations about how and why lyrics were as they were. This is one tale. I’m sure there are many others.
[ii] These, too, are events shrouded in legend and apocrypha by now.

Fisher Investments Analyst’s Book Review: Geopolitics, Battlestars, and the Next 100 Years

March 16, 2010 Comments off

George Friedman’s The Next 100 Years is an ambitious and fascinating glimpse into the future of geopolitics.

That the imagination exists at all is one of the most interesting features of our minds. Conceptualizing and thinking about things outside our immediate perception, or that may not exist at all—to plan for the future and what could be—is not only a spectacular feat, it’s one of the most important differentiators between us and other animals. Forward thinking is the crux of the stock market—not a depiction of the now or the past, but a signaling of the future’s earnings and growth—the crowd’s best guess about what’s next.

Speculating on the future is one of the great pastimes of intellectual life. Years ago I asked science fiction author David Brin what he thought of the genre. He said [paraphrasing], “This isn’t science fiction. It’s speculative fiction. Those who are serious about this genre are endeavoring to make serious and necessary hypotheses about how the future might look.”

So maybe we can call George Friedman’s book, The Next 100 Years, speculative fiction of the most rigorous kind. Dr. Friedman is CEO of Stratfor, a leading geopolitics analysis and information source. He’s done something not many serious geopolitical forecasters would ever dare in public: Forecast how the world might look in 100 years.

Theories about predicting the future have been around forever. Most, in some form or another, use the past to predict what may come. This can be anything from qualitative trend analysis to hardcore statistical arbitrage. Economics, sociology, meteorology, physics, and countless other disciplines (of both the hard and social sciences) aim to know what comes next. In fact, the usefulness of a theory is often defined as its ability to predict.

You’d be hard pressed to find a field with more theories about the future than stock market forecasting. But let’s have no illusions here—thinking 100 years into the future has little or no value for even the longest-term equity investors. At best, market prices are a reflection of a few years from now, but nothing like 20 years, let alone 100.

Nevertheless, this is a useful and provocative book. Friedman’s view of the future includes tremendous insight about the here and now. Everything from how and why geopolitical alliances are formed, to the uses of cutting edge robotic technology, to how today’s global energy turmoil will evolve and rob the Middle East of its current power, and much more.

He’s at his best when explaining why China isn’t necessarily going to be a dominant global power decades from now (as is widely assumed today); at his most interesting and whimsical when speculating on the conquest of space as the next geopolitical frontier (the US will dominate space with “battlestar” war stations by 2060!); and at his weakest when attempting to explain how the year 2080 will look based on current circumstances and decades’ worth of assumptions he’s built up throughout the book (Mexico will vie for dominance of North America!?).

For Friedman, the specifics of the moment or the individuals in power at any given time don’t much matter. Instead, he sees huge, impersonal forces constantly shaping the geopolitical landscape. These forces tend to be cyclical, and tacitly predictable. The details might not be precise, but the outcome over the long run is certain. This isn’t such a far cry from the logic of economics—Adam Smith’s notion of the “Invisible Hand” is just such an inevitable, huge force guiding larger scale free market economies.

That Friedman can make such topics so interesting is a feat in itself. We don’t tend to like reading about the abstract and impersonal—we’d rather our sweeping biographies. Historians, for instance, have a penchant for chronicling decisive events—wars, elections, and so on—but spend comparatively little time on the larger scale, less provocative economic forces that truly shaped the course of history.

In truth, the world’s more random and chaotic than Friedman’s vision, and the true “inevitable” forces that shape things are clearest in hindsight. Friedman himself admits as much. This is a prime reason, for instance, it’s best to only try and forecast stock markets no more than 18 months into the future. Anything longer is treacherous. Think, for example, where your mind was in 2000. Did you see all that would happen these last 10 years—from 9/11, to wars, to housing booms, to recessions, and all the rest?

It’s vital for a society to think forward, and Friedman provides one of the most rational, interesting views of it in some time. But you’re probably best suited keeping your stock market predictions separate from your feelings about battlestars for now.


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