Demographics Is the Next Investing Fad

Looking at history and the long waves of demographics is a great and fine thing. It can tell you a heck of a lot. It’s frequently the case that history is driven by large, abstract, impersonal forces rather than singular decisive events. But…

…to start forecasting equity markets using these metrics is a perilous thing. And it’s becoming all the rage lately.

The problem with demographics as equity market forecasters is that, first, in order for you to be right, you might have to wait, you know, a generation or more. Also, even if you can shoehorn a theory to explain all, at best you only have a few good data points to support the correlation tied to equity markets. That’s not much to stake a +20 year forecast on.

What “Shadow” Home Inventory?

As a follow up to my previous post on housing supply, read Christopher Matthews latest Time Magazine Article: What Ever Happened to the Big, Bad “Shadow Inventory” of Homes?

Why US Home Prices Will Continue to Rise

Dash your expectations for a go-go housing expansion like last decade, but expect a steady recovery in US home prices and a modest GDP tailwind from residential construction. Here’s why:

 

 

 

 

 

 

 

 

 

 

 

Simply, the economy has worked through excess inventory created by the last downturn, and housing supply hasn’t seen these low levels basically since they started recording this sort of thing. This creates significant pressure to expand supply, and that’s been seen—in spades—in recent homebuilder sentiment indexes.

Financial Services Will Get Cheaper, Long-Term

Simply, the long-term cost of financial services is down—technology will see to it. This feature will overwhelm even the politicians’ ability to cause inefficiencies and higher costs.

Million-Dollar Traders Replaced With Machines: Credit Markets– Bloomberg Businessweek

Whatever Happened to the Food Fami-geddon?

Remember just a half-year ago we were supposedly headed for a global nutrition Armageddon? Why didn’t it happen? Because folks largely misunderstand what prices are: one of the ultimate technologies for information transmission. Prices are signals, when they go higher producers (like farmers) respond by shifting available resources (like arable land), investing in increased productivity (like genetically modified seeds and modern irrigation), to get more of those higher prices. In fairly short order, via competition, prices come back down as that new supply (which shows its first signs of life in the futures contract markets and is a reason so-called “speculation” on such things matters and is largely a good thing) comes online.

In the very short term, food prices can spike, drop, shimmy and shammy. Food prices are volatile. But it’s clear by now, once again (because such a scare seems to materialize once every couple years) global food fami-geddon isn’t happening. Generally efficient allocation of resources and utilization of technology via free markets is the reason.

Don’t Think Like an Economist on Europe Anymore

One of my largest recurring gripes is the way economic and financial theory hems folks in to narrow modes of thinking. Every single day for the last two years there have been oodles and oodles of economic analyses on the Europe situation in attempt to figure out how capital markets will react. Stop thinking like an economist—this is a political issue now.

It’s a common debate, as old as economics itself, to ask: Which trumps the other—economics or politics? This is a world where many unfathomable things take place regularly. Virtually no one could envision the LTRO, the EFSF, or any of the other creative “solutions” of the last couple years. And even if you could predict what the next jury-rigged mechanism will be, there’s no telling who or how or when it’ll happen. That’s because, yes, economics are forcing the hands of Europe ’s politicians, but in the end decisions are being made in the political forum.

There is no model or theory that guides here.

Tail Risk Is Not What You Think It Is

“Tail risk” is all the rage today. There are products and prophesies galore on this supposed new topic.

To my mind, most don’t understand what tail risk is. The point of tail risk is that you can’t predict it, and so you then hedge nebulously to guard against the seemingly improbable. So let’s be clear: euro dissolution is not tail risk, though many believe it is. If you, and the rest of the civilized earth believe the euro will die, and that’s widely discussed in all corners of the galaxy, then that’s not a tail risk. Tail risk has an ineffable/unpredictable feature to it. Otherwise, it’s just fear-sodden doom and gloom that you can buy insurance against, often chopping expected returns and raising portfolio costs.

I guess you could sort of define Lehman Brothers as a tail risk. Except that banks fail pretty darn often through history—investment bank failures are not “8 standard deviation events.”  Sorry. I’ve seen a lot of banks fail and I’m relatively young.

Folks are chasing their tails all over the place tied to risk these days. Even if you do recognize tail risk as a real category, no event in the modern era has kept equity markets down for very long. Even 2008. Perpetually hedging against the ineffable has never been a great pathway to wealth, and still isn’t.

Credit Rating Agencies Forget Markets Look Forward

Many of Friday’s headlines read like this:

Bank Downgrades in U.S. Prove Mistaken as Credit Risks Wane

It’s not so much (or perhaps, not only) that Moody’s, Fitch, and S&P are “mistaken” about the banks—it’s that they’re pretty much always the last to recognize reality and reflect it. That’s because, by and large, credit rating agencies pretty much do as human brains are wont: take the recent past and extrapolate it into the future.

This is one of the foremost and ultimate investing mistakes. Capital markets look forward and price in the expected future. Credit ratings agencies are reflecting today in their ratings what’s already done and past about the banks. They, like most folks, are not able to see clearly the future, and therefore use the recent past and assume trend continuation.

Oh, they’ll have their fancy models, special analysts with their special techniques, and other secret sauces to confirm and give authority to their prognostication. But in the end, credit ratings tell you more about the past than the future—making them awful forecasting tools.

“Ro-ro”? Uh-Oh.

The notion of risk-on/risk-off is so tempting to believe in. But it’s rote nonsense and always has been. There is no lever traders and fund managers pull each day where they all decide today is a “risk on” or “risk off” day.

There are millions of separate interests and views affecting the markets, all days, always. That correlations sometimes go up, and sometimes go down tells you nothing about how anything is likely to behave moving forward. Non-serial auto-correlation has been a fact of investing life basically forever no matter how volatility and correlation spikes or quells.

Also, what’s risky changes! What’s risk today is different than perceived risk a few years ago. Remember when the euro was the safest place to be? Now it’s a risk asset!

Don’t be fooled by this stuff—market cycles see changes in leadership and periodic corrections. Volatility and correlation will do the same.

The US GDP Revision is Good News

Yes, Q1 GDP growth was revised down to 1.9% from 2.2%. But look at a basic breakout:

Personal Consumption: +2.7%

Private Domestic Investment: +6.3%

Exports: +7.2%

Imports: +6.1%

(Note: the traditional GDP calculation nets these two out, which then becomes a negative. But this blog has long held that savvy investors like to see big, heavy export and import growth.)

Government: -3.9%

Government -3.9%! Essentially, the US economy is thundering along like a classic Detroit muscle car, while—and supply siders and fiscal hawks alike will love this—the government contracts big time.

Most folks will look only at the top line GDP number and perceive tepidness—looking just one level further reveals a very healthy US economic picture.

(Source: www.bea.gov)